Key Takeaways

  • Both S corps and LLCs provide liability protection and pass-through taxation.
  • LLCs offer greater ownership and management flexibility, with fewer formalities than S corps.
  • S corps may help owners save on self-employment taxes by splitting income into salary and distributions.
  • LLCs can have unlimited members (including non-U.S. residents), while S corps are capped at 100 U.S. shareholders.
  • Formalities, recordkeeping, and compliance obligations are stricter for S corps compared to LLCs.
  • Choosing between the two often depends on your business size, growth plans, and tax strategy.

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.

Which Is Best for Your Business?

When deciding between an LLC and an S corp, consider:

  • Small, flexible businesses may benefit from an LLC’s minimal compliance requirements and broad ownership flexibility.
  • Growth-oriented businesses that plan to retain profits or pay owners partially in dividends may find S corp taxation more efficient.
  • Investor needs: Venture capitalists and institutional investors often prefer corporations (C corps) over LLCs or S corps for scalability.
  • State laws and fees: Some states impose franchise taxes or LLC gross receipts fees that can tilt the balance in favor of one structure over the other.

If you’re unsure which choice best supports your tax strategy and business goals, it’s wise to consult a business attorney or tax professional.

Compliance and Administrative Burden

Compliance obligations are another major factor to weigh:

  • S Corporations: Must adopt bylaws, hold regular board and shareholder meetings, document minutes, and comply with stricter recordkeeping requirements. Failure to meet these obligations could cause termination of S corp status.
  • LLCs: Far fewer formalities are legally required. While creating an operating agreement, holding annual meetings, and documenting major decisions is recommended, they are not mandatory in most states.
  • Ongoing Costs: States may impose annual fees and reports for both structures, but these tend to be lighter for LLCs compared to corporations.

Ownership and Membership Rules

Another key difference when you compare S corp to LLC is ownership eligibility:

  • LLC Ownership: LLCs can have unlimited members, including individuals, corporations, partnerships, trusts, or other LLCs. Foreign nationals can also own LLC interests.
  • S Corp Ownership: Limited to 100 shareholders, all of whom must be U.S. citizens or resident individuals. Other business entities generally cannot own S corp shares.
  • Classes of Equity: LLCs may create different membership classes with varying voting rights or profit shares. By contrast, S corps are restricted to issuing only one class of stock, ensuring equal rights among shareholders.

Tax Considerations When You Compare S Corp to LLC

When you compare S corp to LLC taxation, the differences are significant for long-term planning.

  • LLCs: By default, single-member LLCs are taxed like sole proprietorships and multi-member LLCs like partnerships. Income passes directly to owners’ personal returns, and they must pay self-employment tax on all net earnings.
  • S Corps: Owners who actively work in the business must receive a “reasonable salary” subject to payroll taxes, but additional profits can be distributed as dividends. These dividends are not subject to self-employment tax, potentially reducing the overall tax burden.
  • Flexibility: LLCs can elect to be taxed as S corps, allowing owners to combine operational flexibility with tax savings. However, failure to follow IRS rules on compensation and distributions can risk penalties or loss of S corp status.

Frequently Asked Questions

  1. Can an LLC be taxed as an S corp?
    Yes. LLCs can elect S corp taxation by filing IRS Form 2553, provided they meet shareholder eligibility and operational rules.
  2. Which saves more on taxes, an LLC or an S corp?
    It depends. LLCs face self-employment taxes on all earnings, while S corps allow some profits to be taken as dividends, often lowering payroll tax liability.
  3. Can non-U.S. residents own an S corp?
    No. Only U.S. citizens and residents can be shareholders of an S corp. Non-U.S. individuals, however, can be members of an LLC.
  4. Do both S corps and LLCs protect personal assets?
    Yes. Both structures provide limited liability protection, shielding owners’ personal assets from most business debts and lawsuits.
  5. Which is easier to manage, an LLC or an S corp?
    Generally, LLCs are easier to manage, with fewer formalities and reporting obligations than S corps, which must comply with corporate governance rules.

If you need help with deciding whether an S corporation or LLC is the right choice for your business, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.