Compare S Corp to LLC: Everything You Need to Know
Entrepreneurs must compare S corp to LLC, or limited liability company, to determine which is the ideal legal entity for their new business. 3 min read
Entrepreneurs must compare S corp to LLC, or limited liability company, to determine which is the ideal legal entity for their new business. While an S corporation and an LLC have some similarities, there are also key differences you must familiarize yourself with before making a decision.
Both these business entities become more common when the Small Business Protection Act of 1996 updated corporate tax law with critical changes, such as allowing S corporations to hold any amount of stock in C corporations. Although LLC management and rules vary from state to state, all LLCs provide its owners, known as members, liability protection from business obligations and debts. Many small business owners opt to form LLCs because of their management flexibility and minimal reporting and recordkeeping obligations.
An S corporation is not a business entity, but a tax designation with the Internal Revenue Service (IRS). An LLC can opt to be taxed as an S corporation unless it is a foreign LLC, owned by a nonresident alien, or owned by a partnership or corporation.
A corporation can only have one class of stock and must distribute profits and losses based on each shareholder's interest percentage.
S Corp and LLC Similarities
Both an S corporation and an LLC offer the owners personal limited liability for business debts. Limited Liability allows you to protect assets such as your home or vehicle from business creditors. These business structures are created by filing paperwork with the state and serve as separate legal entities from the owners. However, LLC owners must maintain their "corporate veil" by keeping business and personal finances and affairs completely separate.
Both entities provide pass-through taxation, in which business profits and losses are reported on each member's individual tax return based on his or her ownership percentage. With an LLC, an owner reports income on his or her personal tax return. For example, if you own half of an LLC with $140,000 in net profit, you report income of $70,000 on your individual tax return.
With an S corporation, the owner is paid a reasonable salary and receives remaining profit or loss as a dividend on his or her individual tax return. The salary reduces the business's taxable expenses. For example, if you own 50 percent of a company and receive a $100,000 salary, then receive $10,000 in dividends, you would report income of $110,000 on your tax return.
Although both these business entities are subject to paying fees and filing annual reports with the state, these forms tend to be less extensive for LLCs.
Both business entities can deduct business expenses from their taxable income, including health care premiums, travel and transportation, gifts, advertising and marketing, utilities, and uniforms.
S Corp and LLC Differences
The key differences between an S corp and LLC are the following.
- An S corporation is limited to 100 shareholders, while an LLC can have an unlimited number of owners.
- LLC owners can include those who are not U.S. citizens or residents, but these individuals may not own shares in S corporations.
- LLCs can be owned by other LLCs, partnerships, trusts, C corporations, or S corporations; this is not allowed for S corporations, who must have individuals as owners.
- Subsidiaries for S corporations are restricted, which is not the case for LLCs.
- S corporations have more extensive state requirements. They must issue stock, hold annual meetings for directors and shareholders, adopt bylaws, and keep meeting minutes on record. If they do not adhere to these requirements, they may be unable to maintain S corp status and will be subject to the restrictions of a C corp. LLCs are not subject to these formal requirements. However, it is recommended that an LLC creates an operating agreement, issues shares to members, holds documented annual member or manager meetings, and documents significant decisions and resolutions.
- An S corporation must be managed by appointed corporate officers along with a board of directors, while an LLC can be managed either by the members or by professional managers appointed by the members.
- An S corporation exists in perpetuity while an LLC may be dissolved if a member leaves.
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