Key Takeaways

  • Both LLCs and Subchapter S corporations (S corps) provide limited liability protection and pass-through taxation.
  • An LLC is more flexible, easier to manage, and has fewer IRS restrictions.
  • A Sub S Corp offers potential self-employment tax savings but has stricter eligibility requirements.
  • Ownership, management structure, taxation, and compliance obligations differ significantly between these two entities.
  • Choosing between a Sub S Corp vs LLC depends on your business’s goals, tax situation, and future growth plans.

If comparing the LLC vs. Sub S Corporation, then you will need to first identify which solution is better for your business. While both business structures share similar qualities, they have some key differences in the way in which they operate. Specifically, LLCs are easier to form, easier to manage, and take less time to ensure compliance with state and federal regulations. However, S corps allow you to share stock to investors. While both business structures are good options, and they both offer some level of personal liability protection, you’ll want to take a look at all of the benefits and potential disadvantages to operating an LLC or S corporation.

Similarities Between an LLC and S Corporation

There are many similarities between an LLC and an S corporation, including limited liability protection for its owners. This means that the owners are usually not personally liable for the debts of the business. Similarly, both business structures operate as pass-through tax entities, meaning that the profits of the business are passed through to the owners. If taxes are due on those profits, the owners of the business must pay the taxes. Furthermore, both businesses can deduct pre-tax expenses, i.e., travel, phone, car, gifts, advertising, computers, etc.

Differences Between an LLC and S Corporation

There are many differences between an LLC and S corporation, and you should be well educated in these differences, so that you know which type of business structure is the right choice for your goals and business objectives. Some of these differences can be found in the following areas:

  • Ownership
  • Management
  • Length of existence
  • Transferability
  • Self-employment tax

Tax Treatment and IRS Elections

When comparing a Sub S Corp vs LLC, taxation is one of the most critical distinctions. An LLC is automatically treated as a pass-through entity for federal tax purposes—profits and losses flow directly to members, who report them on personal returns. However, LLCs also have flexibility; they can elect to be taxed as an S corporation by filing Form 2553 with the IRS.

This election can reduce self-employment taxes since only the owner’s salary (not the entire profit) is subject to FICA taxes. The remainder can be distributed as dividends, which are not subject to self-employment tax. In contrast, if an LLC remains a default pass-through entity, all net income is taxed as self-employment income.

S corporations must adhere to stricter IRS rules. They can issue only one class of stock and cannot have more than 100 shareholders—all of whom must be U.S. citizens or residents.

Ownership

There are restrictions when it comes to S corporations; as such, S corporations cannot have more than 100 owners (shareholders). LLCs, however, can have an unlimited number of members.

The IRS provides that non-U.S. citizens can be members of LLCs, but such persons cannot be owners of S corporations.

There are several formalities regarding the ongoing maintenance of an S corporation, including the adoption of bylaws, issuing of stock, conducting annual shareholder meetings, along with keeping meeting minutes.

With regard to the LLC, the only formalities include the adoption of an operating agreement (not required in most states), issuance of membership shares (referred to as distributive shares), having periodic or annual meetings, and documenting all significant decisions. Keep in mind that the LLC formalities are not requirements, and are only formalities that are recommended by most states.

Eligibility and Restrictions

An LLC can have an unlimited number of members, including individuals, corporations, and foreign entities. In contrast, an S corporation is limited to 100 shareholders, and all must be U.S. citizens or residents. Additionally, S corporations cannot be owned by other corporations, LLCs, partnerships, or many types of trusts.

These restrictions can make an LLC a better fit for businesses with diverse investors or plans to expand internationally. However, entrepreneurs seeking payroll benefits and structured tax savings might prefer the S corp election.

Furthermore, S corps must maintain only one class of stock, whereas LLCs allow flexible membership interests and customized profit distributions among members.

Management

LLC owners can choose to operate a member-managed or manager-managed LLC. If the members manage the LLC, it essentially operates very similarly to a partnership. If a manager operates the LLC, then the LLC resembles a corporation, as the members are only involved in the significant business decisions and not the daily operations of the business.

S corps, however, have directors and officers. The board of directors oversees the daily operations of the corporation, while also handling all major decisions. With regard to the S corps daily operations, the board of directors hires officers who oversee such daily operations.

Length of Existence

An S corporation’s existence can last forever, whereas some states provide that an LLC must identify a dissolution date. For example, certain events might trigger the dissolution of an LLC, i.e., death or withdrawal of a member.

Transferability

S corporation stock can be freely transferred, whereas the ownership in an LLC is usually not freely transferable, and must be approved by a majority (or all) members in the LLC. This is generally laid out in the LLC Operating Agreement.

Growth and Investment Potential

LLCs generally allow more flexibility in structuring ownership interests and profit distributions, making them ideal for small businesses or family-owned operations. However, transferring ownership can be more complex—typically requiring the consent of other members.

S corporations, by contrast, can transfer stock more freely, which may make them more attractive to outside investors. Still, since they can issue only one class of stock and cannot include non-U.S. investors, their ability to raise capital remains limited compared to C corporations.

For entrepreneurs planning to seek significant investment or go public in the future, starting as an LLC may offer flexibility, while later converting to a corporation could open more financing opportunities.

Self-Employment Tax

S corporation owners might not need to pay self-employment taxes, particularly if the S corp owner is treated as an employee and paid a “reasonable” salary by the corporation. Generally, LLC members are required to pay self-employment taxes on their share of profits; this is paid on their personal tax returns.

Payroll, Distributions, and Tax Savings

S corporations can provide meaningful self-employment tax advantages when structured properly. Owners who work for the business must draw a reasonable salary, which is subject to payroll taxes (Social Security and Medicare). However, profits distributed as dividends are exempt from these taxes, potentially lowering the total tax burden.

LLC members, on the other hand, typically pay self-employment tax on the entire business income. By electing S corp status, LLC owners can balance between payroll income and distributions, optimizing their tax liability while maintaining limited liability protection.

However, S corps must follow payroll reporting rules, file quarterly employment taxes, and maintain accurate corporate records. For small or single-member LLCs with minimal administrative resources, these compliance costs may outweigh potential savings.

Choosing Between an LLC and Sub S Corporation

When evaluating Sub S Corp vs LLC, consider your business’s goals:

  • Choose an LLC if you want flexibility, minimal paperwork, and fewer restrictions on ownership. It’s ideal for small or single-member businesses that want straightforward management.
  • Choose an S Corporation if your business earns significant profits, you plan to pay yourself a salary, and you want to reduce self-employment taxes.

In some cases, business owners form an LLC and later elect S Corp taxation—combining the flexibility of an LLC with the tax efficiencies of an S corporation.

Before deciding, consult a business attorney or tax professional. You can find experienced attorneys on UpCounsel who can help structure your entity for long-term growth and compliance.

Frequently Asked Questions

  1. Can an LLC be taxed as an S Corporation?
    Yes. An LLC can elect S corporation taxation by filing IRS Form 2553 if it meets eligibility criteria. This allows owners to pay themselves a salary and take profit distributions that may reduce self-employment taxes.
  2. What’s the main tax advantage of an S corporation?
    S corp owners can classify part of their income as dividends rather than wages, potentially lowering FICA taxes, provided they pay themselves a reasonable salary.
  3. Can foreign investors own an S Corporation?
    No. Only U.S. citizens or resident aliens can be shareholders in an S corporation. LLCs, however, can have foreign owners.
  4. Which is better for a small business: LLC or S corp?
    For small startups or freelancers, an LLC is usually simpler and more flexible. Businesses with higher profits or employees may benefit more from S corp tax treatment.
  5. Can I convert my LLC to an S corporation later?
    Yes. Many business owners start as LLCs and later elect S corporation status when profits increase. This can be a strategic move to reduce taxes while maintaining limited liability.

If you need help determining whether you should form an LLC or S corp, 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.