Limited Liability S Corporation: Everything You Need to Know
An LLC and an S Corp are similar in that they both offer limited liability protection for their owners. Both have advantages and disadvantages.3 min read updated on February 01, 2023
Limited liability S corporation is something that many entrepreneurs take into consideration when they are deciding which business structure they should adopt. A limited liability company (LLC) and an S corporation are similar in that they both offer limited liability protection for their owners and generally pass their incomes or losses through to their owners for tax purposes. Both of these business structures have their advantages and disadvantages.
Similarities Between an LLC and S Corporation
Limited Liability Protection
Both LLC and S corporation are separate legal entities that are formed by filing with a state agency. As such, they protect their owners from being personally liable for their liabilities and debts.
Typically, both LLC and S corporation are pass-through tax entities. While an S corp is required to file business tax returns, an LLC only files business tax returns if it has more than one owner. As pass-through tax entities, these two types of business structure do not have to pay income taxes at the business level. Instead, profits or losses will be passed through to the personal tax returns of their owners. This means that they pay all necessary taxes at the individual level.
In addition, both LLC and S corporation can claim deductions for pre-tax expenses such as advertising, promotion, travel, computer, uniform, gift, travel, car, and health insurance expenses.
Ongoing State Requirements
An LLC and an S corporation are also similar in that they are both subject to state-imposed formalities, including filing annual reports and paying the required fees.
Differences Between an LLC and an S Corporation
An LLC can have any number of members, while an S corp can only have a maximum of 100 shareholders. Non-U.S. citizens or residents cannot be shareholders in an S corp, but they can be members of an LLC. Also, the shareholders of an S corporation cannot be partnerships, LLCs, other corporations, or certain trusts, but an LLC can have subsidiaries without restriction.
An S corporation can transfer its stock freely, as long as it complies with the ownership restrictions imposed by the IRS. In an LLC, however, membership interest is typically only transferable with approval from other members.
An S corporation is required to comply with stricter internal formalities. An LLC, on the other hand, does not have to follow internal formalities, although it is recommended that it does so.
Required formalities for an S corp include:
- Imposing bylaws
- Issuing stock
- Conducting initial and annual shareholder and director meetings
- Keeping minutes of meetings
Recommended formalities for an LLC include:
- Issuing membership shares
- Drafting an operating agreement
- Conducting and keeping minutes of annual member meetings
- Documenting every major business decision
An LLC can be member-managed or manager-managed. A member-managed LLC is similar to a partnership, while a manager-managed LLC resembles a corporation, with its members not involved in making day-to-day business decisions. An S corp has a board of directors and officers. The directors are responsible for overseeing corporate affairs and making important decisions, but they are not involved in the daily operations of the corporation. Instead, officers are elected to handle daily business affairs.
In an LLC, taxes are paid on the individual tax returns of the owners, based on their ownership percentages. An S corporation pays owners who perform work a reasonable salary. Then, the remaining profit or loss will flow through to the personal tax returns of the owners.
An S corporation's self-employment taxes may be preferable compared to an LLC's because its owners can be treated as employees and paid a salary. After paying salaries to its owners, its corporate earnings may be considered unearned income, which is not subject to self-employment taxes.
Is LLC or S Corporation a Better Option?
An LLC is a more suitable option if:
- You are the owner of a startup or online business
- You want to pay taxes like an S corporation while retaining LLC structure
- You do not want to sell stocks
- You want minimal paperwork
- You want more flexibility
An S corporation is a better option if:
- You own a fast-growing business and intend to share ownership with your employees or bring on investors
- You want to create more separation between you and your company to attract more investors
- You want more liability protection
If you need help with choosing between LLC and S corporation, 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.