LLP vs S Corp: Which Is Better for Your Business?

Key Takeaways

• LLPs are often ideal for professional services firms where liability protection is needed but corporate formalities are not.
• S Corps can offer self-employment tax advantages and appeal to small businesses looking for formal structures with flexible tax treatment.
• LLPs have fewer ownership restrictions, while S Corps have limitations on shareholders and require stricter compliance.
• Profit distribution, tax filing, and management roles differ significantly between LLPs and S Corps.
• Your choice between LLP vs S Corp should consider liability protection, taxation, ownership flexibility, and industry suitability.

LLP vs S corp is a consideration that some entrepreneurs make when they are choosing a legal structure for their business. A limited liability partnership (LLP) is a business entity with two or more owners who are protected from being personally liable for its financial obligations. An S corp, on the other hand, is a corporation that enables its income to flow through to its shareholders for tax purposes while also providing liability protection for them. Entrepreneurs who are choosing between these two business structures should properly weigh their pros and cons before making the final decision.

What Is an LLP?

An LLP is a form of business that has more than one owner and gives them protection against liability for business debts. It must have at least two partners and can only be established by licensed professionals, such as doctors or attorneys. The partners are general partners, but they are not personally liable for other partners' or employees' actions. In the event that a partner accrues debt or claims, the personal assets of other members will not be subject to seizure.

An LLP can be structured and managed more easily than a corporation, making it a preferred option for professionals who only seek to protect their personal assets. An LLP and a limited liability company (LLC) are similar in many ways, but the former operates according to partnership rules.

Key Advantages and Disadvantages of LLPs

LLPs are designed to provide liability protection without imposing the rigid formalities of a corporation. Here are key pros and cons:

Advantages:

• Limited liability: Partners aren't personally liable for business debts or the malpractice of other partners.
• Flexible structure: LLPs allow for flexible profit distribution and management roles.
• Pass-through taxation: Income is reported on partners’ personal tax returns, avoiding double taxation.

Disadvantages:

• Availability limitations: Some states restrict LLP formation to specific professions like law or medicine.
• Lack of outside investment: LLPs can’t issue stock, making it harder to raise capital.
• Self-employment taxes: Partners may still be subject to self-employment taxes on income received.

What Is an S Corporation?

Also referred to as a Subchapter S corporation, an S corporation offers the limited liability protection of a corporation but pays taxes in the same way as a partnership, with its income or loss passing through to its shareholders. The IRS allows eligible C corporations to elect S corp status if they wish to change the way their profits will be taxed.

An S corporation is not formed through registration with a state. Before you file S corp election, you must first form a corporation. You are required to file the election within a certain timeframe, so you should check with your accountant or tax professional to make sure that the filing is properly done. An S corp is required to meet the following requirements:

• Must be a domestic business with 100 or less shareholders
• Must not have shareholders who are non-U.S. citizens or residents
• Must not have shareholders that are partnerships, LLCs, corporations, or certain trusts
• Must comply with certain bureaucratic requirements, including imposing bylaws, issuing stock, and holding and keeping accurate minutes of shareholder and director meetings

Similar to a C corporation, an S corporation has a board of directors and officers. The directors oversee corporate affairs and make major decisions, but they do not handle the day-to-day operations of the corporation. Instead, they elect officers to manage daily business affairs. One advantage of an S corporation is that its stock can be transferred freely, as long as it meets the IRS ownership restrictions. The shareholders of an S corporation are not personally liable for business debts, but they are required to pay individual income tax on the salaries and dividends they receive from the corporation.

An S corp does not have to pay taxes at the corporate level. Similar to an LLC, it is a pass-through entity that distributes its profits or losses to its owners. However, its self-employment taxes may be preferable compared to that of an LLC because its owners can be regarded as employees and paid reasonable salaries. After salaries are paid, the remaining corporate earnings that are distributed to shareholders can be regarded as unearned income. As such, they are not subject to self-employment taxes.

Compliance Requirements for S Corps

Running an S corporation entails meeting several ongoing compliance obligations, including:

• Filing Form 1120S annually with the IRS.
• Issuing K-1 forms to shareholders showing their share of income or loss.
• Holding annual meetings and maintaining detailed corporate records.
• Adhering to shareholder restrictions: Only U.S. citizens or residents can be shareholders, and the business cannot have more than 100 shareholders.

These rules help maintain the S Corp’s tax status but may be burdensome for smaller businesses not equipped for formal corporate governance.

S Corp vs. LLC with Partnership Tax Structure

It is important to consider the issue of self-employment tax savings if you are able to reduce your self-employment taxes. If you have ownership interest in an LLC that pays taxes as a partnership, it is likely that you will have to pay self-employment taxes on your income, unless you are not an active member or work less than 500 hours. Members of such an LLC are not regarded as employees, so they are not on payroll. In an S corporation, directors and officers will receive payroll payments as part of their compensation.

LLP vs S Corp: Key Differences at a Glance

Here's a side-by-side breakdown of the main differences between an LLP and an S Corp:

Frequently Asked Questions

1. Can you convert an LLP to an S Corp? Yes, you can convert an LLP to an S Corp, but it involves dissolving the partnership and forming a new corporation, then electing S Corp status via IRS Form 2553.

2. Which is better for a professional services firm: LLP or S Corp? Generally, an LLP is better for licensed professionals due to its flexible structure and limited liability without the need for corporate formalities.

3. Does an S Corp save more on taxes than an LLP? Potentially yes—S Corp owners may reduce self-employment taxes by paying themselves a reasonable salary and taking the rest as distributions, which are not subject to self-employment tax.

4. Can an LLP have shareholders? No, LLPs do not issue shares. They are owned by partners, not shareholders.

5. Is liability protection the same in an LLP and S Corp? Not exactly. In an LLP, each partner is only protected from liabilities caused by other partners. In an S Corp, all shareholders enjoy complete limited liability protection.

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