Whether you’re just starting a business or thinking of changing your business structure, a common first step is comparing LLC vs. S corp. While a limited liability company and S corporation share many qualities, they also have distinct differences. Get familiar with each before deciding which might be right for you.
LLCs and S corps have much in common:
- Limited liability protection. With both, owners are typically not personally responsible for business debts and liabilities.
- Separate entities. Both are separate legal entities created by a state filing.
- Pass-through taxation. Both are typically pass-through tax entities, and while S corps must file a business tax return, LLCs only file business tax returns if the LLC has more than one owner. With pass-through taxation, no income taxes are paid at the business level. Business profit or loss is passed-through to owners’ personal tax returns. Any necessary tax is reported and paid at the individual level.
- Ongoing state requirements. Both are subject to state-mandated formalities, such as filing annual reports and paying the necessary fees.
Differences in ownership and formalities
Ownership. The IRS restricts S corporation ownership, but not that of limited liability companies. IRS restrictions include the following:
- LLCs can have an unlimited number of members; S corps can have no more than 100 shareholders (owners).
- Non-U.S. citizens/residents can be members of LLCs; S corps may not have non-U.S. citizens/residents as shareholders.
- S corporations cannot be owned by C corporations, other S corporations, LLCs, partnerships or many trusts. This is not the case for LLCs.
- LLCs are allowed to have subsidiaries without restriction.
Ongoing formalities. S corporations face more extensive internal formalities. LLCs are recommended, but not required, to follow internal formalities.
- Required formalities for S corporations include: Adopting bylaws, issuing stock, holding initial and annual director and shareholder meetings, and keeping meeting minutes with corporate records.
- Recommended formalities for LLCs include: Adopting an operating agreement, issuing membership shares, holding and documenting annual member meetings (and manager meetings, if the LLC is manager-managed), and documenting all major company decisions.
Differences in management
- Owners of an LLC can choose to have members (owners) or managers manage the LLC. When members manage an LLC, the LLC is much like a partnership. If run by managers, the LLC more closely resembles a corporation; members will not be involved in the daily business decisions.
- S corps have directors and officers. The board of directors oversees corporate affairs and handles major decisions but not daily operations. Instead, directors elect officers who manage daily business affairs.
Other differences between S corps and LLCs include:
- Existence. An S corporation’s existence is perpetual, but some states require LLCs to list a dissolution date in the formation documents. Certain events, such as death or withdrawal of a member, can cause the LLC to dissolve.
- Transferability of ownership. S corporation stock is freely transferable, as long as IRS ownership restrictions are met. LLC membership interest (ownership) typically is not freely transferable—approval from other members is often required.
- Self-employment taxes. S corporations may have preferable self-employment taxes compared to the LLC because the owner can be treated as an employee and paid a reasonable salary. FICA taxes are withheld and paid on that amount. Corporate earnings after payment of the salary may be able to be treated as unearned income that is not subject to self-employment taxes. For more information and whether this might apply to your particular situation, please contact your accountant or tax adviser.