Compare Business Structures
S Corp vs. LLC
Choosing between an S Corp and a Limited Liability Company (LLC) can shape how your business operates. Explore our guide to understand which option is better suited for your business's success.
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Business Structure Differences
Two important terms you’ll see when researching how to set up your new business are LLC and S corp. They’re very different things, but they both impact how your company will be taxed. This article will help you understand the advantages and disadvantages of each business type.
The difference between S corp and LLC is so stark because, for starters, they’re not even in the same category. A limited liability company (LLC) is a type of legal business entity. But an S corporation (S corp) isn’t a business entity at all. It’s a tax status that an LLC or a corporation can apply for with the IRS if it meets certain criteria. For an LLC, filing as an S corp has the potential to save the owners a great deal in self-employment taxes.
For the purposes of this article, we’ll be comparing a typical LLC and an LLC with S corp tax election. If you’d like to know more about how each of them compares to a corporation, see our S Corp vs. C Corp page and our LLC vs. Corporation page.
Difference Between LLC and S Corp
The essential difference is an LLC is a legal business structure, whereas an S corp is a tax filing status. But let’s compare a standard LLC to an LLC with S corp election. First, we’ll examine the advantages an LLC with S corporation election has over an LLC without S corporation election.
Advantages of LLC with S Corp Election
Standard LLC – The members of a standard LLC can’t be employed by the business. The money they make from the LLC comes from distributions, a.k.a. their share of the profits. They must then pay 15.3% in self-employment tax on all those profits. If the LLC is particularly profitable, that can add up to a sizable chunk of change.
LLC w/S corp election – An LLC with S corporation election can pay its members in two ways, in distributions and a salary from the LLC. In that case, the members would only pay employment taxes (Social Security and Medicare) on their salary from the LLC, but not on the distributions. Again, in a more profitable business, the tax savings can add up. Money paid out as salary is also a tax-deductible expense for the business.
Advantages of LLC without S Corp Election
Traditional limited liability companies also have some advantages over those with S-corp election:
Requirements for S Corporations
The Internal Revenue Service (IRS) has stricter requirements for businesses with S corp designation. For an LLC or corporation to qualify for S corporation election, the Internal Revenue Code says they must:
- Be a domestic corporation or LLC
- Have no more than 100 shareholders or members
- Have only allowable shareholders or members, which includes individuals, certain trusts, and estates. The shareholders may not be partnerships, corporations, or non-resident aliens; a nonresident alien is an alien who has not passed the green card test or the substantial presence test. However, an S corp can own other businesses.
- Not be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations
- Have only one class of stock
As you can see, these restrictions would limit the number and type of members an LLC set up as an S corporation could have. A traditional LLC could have more than 100 members and be owned by corporations, partnerships, and non-resident aliens.
More IRS Scrutiny
Remember what we said about LLC members being required to pay themselves a “reasonable salary”? The IRS watches this closely to prevent abuse. If your salary is inadequate, you’re not contributing enough to Social Security and Medicare.
That’s why the IRS expects you to pay yourself a reasonable salary. But how does the IRS define “reasonable compensation”? The instructions on Form 1120-S read, “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.”
While those instructions don’t provide a 100% clear definition, the IRS seems to consider “reasonable” to be something similar to what others in your field are earning for the same work.
All of this means that a business with S corp designation is more likely to be audited than one without. And, if the IRS decides that your salary is not reasonable, it has the authority to reclassify your non-wage distributions (which are not subject to employment tax) to wages (which are subject to employment tax). Several court cases have supported the IRS’s right to do this.
Additional Accounting and Bookkeeping
Having an LLC filing as an S corporation generally means more paperwork. If you don’t already have to do payroll and calculate payroll taxes for your business, being an owner-employee means that you’ll have to do so. Your taxes will be more complex, as well.
With these added complications, you’re likely to have higher administrative costs. You may find that you need an accountant, bookkeeper, and/or a payroll service or software.
How We Can Help
Now that you understand the difference between LLC and S corp, you’ll have to weigh all the factors to see which choice best fits you and your business. We don’t recommend doing this alone, though. It’s times like these when you need a skilled tax professional to help you make an informed decision.
If you’re planning to start an LLC, with or without the S corp designation, we can handle the process for you. Our LLC formation service sets you up with experts who can file the paperwork with the state for you. And, if you’d like to form your LLC as an S corp, our S corporation service can take care of that added step, too. Once you’re established, we have other services like Worry-Free Compliance to help you stay compliant with government regulations.
You can do this. We can help.
S Corporation and Limited Liability Company FAQs
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An LLC provides limited liability protection to its members, shielding personal assets from business liabilities and debts. While corporations offer similar protection, they often face double taxation, taxing profits at the corporate and individual shareholder levels. LLCs, however, can opt for pass-through taxation, where profits are only taxed at the individual level. Additionally, LLCs have the flexibility to choose between being taxed as a corporation or a pass-through entity, offering potential tax benefits. Unlike corporations, LLCs have fewer organizational requirements, making them a more streamlined option for business owners. -
An “S corp” designation is a tax filing status available to LLCs or corporations, primarily aimed at small businesses and subject to certain limitations, such as a maximum of 100 owners. While both S corps and LLCs offer pass-through taxation for federal income taxes, the appeal of electing S corp status lies in minimizing self-employment taxes. Normally, LLC members are considered self-employed and are taxed at a higher rate on all profits received from the LLC. However, by opting for S corporation status, members can receive compensation both as profits and as employees, allowing them to only pay self-employment tax on their salary, not on profits. It’s essential to ensure a “reasonable salary” is paid to avoid IRS scrutiny. -
You will first need to form a limited liability company or corporation, if you haven’t already done so. Then you would file Form 2553, Election by a Small Business Corporation, with the IRS to get S corp status.
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Owners of an S corp can pay themselves a salary from the company. They’ll pay employment taxes on that salary, but they won’t have to pay self-employment taxes on the remaining profits. This could mean substantial savings and is one of the benefits of an LLC filing as an S corp. (Note that the LLC members will still be responsible for income and other applicable taxes on the profits.)
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That will depend on your business’s circumstances (again, a tax professional can help here). As far as the time of year to file, the IRS requires that you complete and file your Form 2553 within 75 days of the formation of your LLC or C corporation or no more than 75 days after the beginning of the tax year in which the election is to take effect. You can also file at any time during the tax year preceding the tax year the election is to take effect. The IRS has more details on the instructions for Form 2553.
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An S corp is a tax classification, while an LLC is a business structure. LLCs and corporations can both apply to be S corps if they meet the IRS’s criteria.
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Whether or not your LLC should apply to become an S corp depends on many factors, including how profitable your business is and how much paperwork you’re comfortable with. An experienced accountant can help you run the numbers to see what would most benefit your company financially.
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At the present time, our S corp service is only for applying for S corporation status when you form your LLC with us. We do offer plenty of other services to support your established business, though.
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Pass-through taxation occurs with a business structure like a sole proprietorship, partnership, or LLC, where the profits for the business are only taxed once, when they’re distributed to the individual members. This is as opposed to double taxation, in which the business itself is taxed on the profits before they’re distributed to the individual owners, where they’re taxed a second time.
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Yes. Only having one business owner doesn’t disqualify an LLC from filing to be an S corp.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Entity Comparisons
