LLP vs S Corp: Everything You Need to Know
Entrepreneurs who are choosing between these two business structures should properly weigh their pros and cons before making the final decision.3 min read
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.
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.
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.
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