Limited Liability Company vs S Corporation: Everything You Need to Know
There's often confusion between a Limited Liability Corporation vs S corporation when it comes to corporate structures. 3 min read
2. How are LLCs and S Corporations Taxed?
3. Similarities Between LLCs and S Corporations
4. Differences between LLCs and S Corporations
There's often confusion between a Limited Liability Corporation vs S corporation when it comes to corporate structures. Small business owners prefer to form an LLC due to their flexibility and fewer recordkeeping and reporting obligations, but they may not be aware of the differences between an LLC and an S corporation.
LLC vs S Corporation
An LLC is not a corporation, but an S corporation is not a business entity. Instead, the S corporation refers to how the business has decided to undergo taxation by the IRS. And the IRS allows an LLC to switch to an S corporation if so desired. However, it's not possible to switch back once the change to an S corporation has been made.
How are LLCs and S Corporations Taxed?
All businesses are taxed on their net profit or loss. This is determined by taking the amount of sales and subtracting allowable deductible expenses. For an LLC, this is done via the tax paid on the owner's personal tax return and based on their percentage of ownership in the company. As an example: If you are the 75 percent owner of an LLC with $100,000 in net profit, you pay on taxes on 50 percent of that net profit ($50,000) on your personal tax return.
In the event a single-member LLC is partnership">taxed under sole proprietorship tax rules, the LLC member reports the business income and expenses on Schedule C of their personal tax return and pays personal income tax on any profits generated by the company. The sole member is considered self-employed and has to pay the full Social Security and Medicare taxes on the profits as they are treated as income.
In contrast, an S corporation pays a salary to the working owner of the business. The salary paid to the owner by the S corporation is subject to federal and state payroll taxes. Any remaining profit or loss after the salary has been deducted passes through to the personal tax return of the owner. Some states charge a minimum corporate tax that may be more expensive than the fees that are associated with an LLC.
Similarities Between LLCs and S Corporations
Both an LLC and S corporation have a major advantage in that owners and members are able to shield their assets from business creditors. Limited liability means that the members are not financially responsible for more than their investment in the company.
Both legal structures are separate legal entities that are created by filing with a state. They are also usually pass-through tax entities. But an S corporation has to file a business tax return while the LLC only files if there is more than one owner. Pass-through taxation means no income taxes are paid on the business level. Any business profit or loss gets passed-through to the personal tax return of the owner.
LLCs and S corporations are able to deduct pre-tax expenses that include:
- Computer equipment
- Office equipment and supplies
- Phone bills
- Vehicle expenses
- Health care premiums
Differences between LLCs and S Corporations
The IRS puts restrictions on S corporations, but not LLCs. An LLC has no limit to its amount of members while an S corporation can have no more than 100 owners or shareholders. LLCs are allowed to have non-U.S. citizens or residents as members whereas an S corporation may not. LLCs can have subsidiaries and there are no restrictions on how many while an S corporation cannot be owned by a C corporation, LLC, partnership, or many kinds of trusts.
LLCs don't have to follow internal formalities whereas S corporations have extensive internal formalities. They include:
- Adopting bylaws
- Issuing stock
- Holding an initial and annual director and shareholder meetings
- Keeping minutes
It is recommended for LLCs to do the following:
- Adopt an operating agreement
- Issue membership shares
- Holding and documenting annual member meetings
- Documenting all company decisions
An LLC may be the best choice for a new business owner to establish as it's usually less expensive to form and administer. There's also the option to be taxed as an S corporation while retaining the structure of an LLC. Always consult with a professional to determine which business structure is the right one.
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