When starting a business, one of the most important decisions you'll make is choosing the right business structure. There are a variety of business structures that different companies choose for different reasons, each having its pros and cons. Two popular options are the limited liability company (LLC) and the S-Corporation (S-Corp). While both offer unique advantages and limitations, they also have distinct differences. Here's a breakdown of the key differences between LLCs and S-Corps to help you decide which might be right for your business.
LLCs and S-corps share some similarities, including:
Separate entities:
Both LLCs and corporations are considered separate legal entities from the business owner. This distinction is created by a filing with the state. Once a corporation or LLC has been formed, it can choose to be taxed as an S-corporation by filing IRS Form 2553, "Election as a Small Business Corporation," with the IRS.
Pass-through taxation:
Both LLCs and S-corps are pass-through entities, meaning that the business is not required to pay taxes on its profits. Alternatively, the profits and losses are "passed through" to the owners of the business, who report them on their own personal tax returns.
Limited liability protection:
Both LLCs and S-corps offer limited liability protection to their owners, meaning that the owners' personal assets are generally protected from the business's debts and legal liabilities.
While LLCs and S-corps share some similarities, they also have distinct differences in ownership, management, and ongoing formalities.
Restrictions on ownership:
The IRS rules restrict S-corporation ownership but not that of limited liability companies. S-corps cannot have more than 100 shareholders, and these shareholders must be U.S. citizens or residents. LLCs, on the other hand, can have an unlimited number of members, and those members can be individuals, corporations, or other entities.
Allocation of profits and losses:
S-corps must distribute earnings proportionately to the shareholders' ownership percentage, while LLCs have more flexibility in allocating profits and losses based on criteria other than ownership percentage.
Management structure:
S-corps require a board of directors to oversee the company, while LLCs have more flexibility in their management structure. LLCs can be member-managed, meaning that the owners manage the company, or manager-managed, meaning that the owners hire a manager to run the company.
Self-employment taxes:
S-corp owners who work for the company must pay themselves a reasonable salary and are subject to self-employment taxes on that salary. S-corp owners can potentially reduce their self-employment tax liability by paying themselves this reasonable salary and then taking the remainder of their income as distributions.
This is how it typically works: S-corp owners who are actively involved in the business are required to pay themselves a reasonable salary. This salary is subject to payroll taxes, which include Social Security and Medicare taxes (collectively known as self-employment taxes). In addition to their salary, S-corp owners can receive distributions of the company's profits. These distributions are not subject to self-employment taxes. Instead, they are generally subject to regular income tax.
LLC owners, on the other hand, are generally subject to self-employment taxes on their share of the business's profits.
Formalities:
S-corps have much more ongoing formalities than LLCs. For example, S-corps must hold annual meetings of shareholders and directors, keep minutes of those meetings, and file annual reports with the state. LLCs, on the other hand, have fewer formalities and are generally easier to maintain.
Management flexibility:
LLCs offer more flexibility in their management structure, allowing owners to choose between member-managed and manager-managed structures.
Allocation of profits and losses:
LLCs have more flexibility in allocating profits and losses based on criteria other than ownership percentage.
Fewer formalities:
LLCs have fewer ongoing formalities than S-corps, making them much simpler to operate and maintain.
Self-employment taxes:
LLC owners are generally subject to self-employment taxes on their share of the company's profits.
Limited investment options:
LLCs cannot issue stock, which can limit their ability to raise capital to help grow their businesses.
Pass-through taxation:
S-Corps are pass-through entities, meaning that the business itself does not pay taxes on its profits.
Salary and distributions:
S-corp owners who work for the company may be paid through a combination of a reasonable salary and distributions, which can result in a lower overall tax burden.
Investment options:
S-Corps can issue stock, which can make it easier to raise capital to help grow their companies.
Restrictions on ownership:
S-corps can have no more than 100 shareholders, and those shareholders must be citizens of the United States or residents.
More formalities:
S-corps have more ongoing formalities than LLCs, including annual meetings of shareholders and directors, and minutes of those meetings.
Choosing between an LLC and an S-corp depends on your business's specific needs and goals. Here are some factors to consider when making your decision:
Ownership:
If you want more flexibility in ownership and don't want to be limited to U.S. citizens or residents, an LLC may be a better choice.
Management:
If you want more flexibility in your management structure, an LLC may be a better choice.
Taxes:
If you want to potentially lower your overall tax burden, an S-corp may be a better choice.
Formalities:
If you want fewer ongoing formalities, an LLC may be a better choice.
Investment options:
If you want to issue stock to raise capital, an S-corp may be a better choice.
An LLC has the option to choose to be taxed as an S-corp. To do so, an LLC must file IRS Form 2553, Election by a Small Business Corporation. Being taxed as an S-corp can potentially help the owners of the LLC to reduce their overall tax burden.
It's important to note that while an LLC can elect to be taxed as an S-corp, it may not always be the best choice. For example, an LLC that is taxed as an S-corp may have more ongoing formalities than an LLC that is not taxed as an S-corp. Additionally, there may be negative aspects to electing S-corp tax classification for LLCs, such as practical problems the election can present.
Ultimately, the decision between an LLC and an S-corp depends on your business's specific needs and goals. It's important to consult with a qualified professional before making your decision to ensure that you choose the right business structure for your business.
In addition to the factors mentioned above, there are other considerations to keep in mind when choosing between an LLC and an S-corp. For example, if you plan to take your business public in the future, an S-corp may be a better choice because it can be converted to a C-corp more easily than an LLC. Additionally, if you plan to offer equity to employees or investors, an S-corp may be a better choice because it can issue stock.
Another factor to consider is the state in which you plan to form your business. Some states have more favorable tax laws for LLCs, while others have more favorable tax laws for S-corps. It's important to research the tax laws in your state before making your decision.
Finally, it's important to consider the long-term goals of your business. If you plan to keep your business small and family-owned, an LLC may be a better choice. If you plan to grow your business and eventually sell it, an S-corp may be a better choice because it can offer more flexibility in ownership and management.
Choosing between an LLC and an S-corp is an important decision that requires careful consideration of your business's specific needs and goals. By weighing the advantages and disadvantages of each structure and consulting with a qualified professional, you can make an informed decision that will help your business succeed in the long run.
MyLLC.com provides a wide range of services to help entrepreneurs start and manage their businesses; this includes assistance in choosing between an LLC and S-corp and other business structures. Here are some ways that MyLLC.com can help:
Overall, MyLLC.com can be a valuable resource for entrepreneurs who are starting or managing a business and need assistance in choosing between an LLC and an S-corp. With their range of services and commitment to exceptional customer service, we can help you navigate the complexities of starting and running a successful business.
