Pros and Cons of LLC and S Corp

There are various pros and cons of LLC and S corp that all business owners should be mindful of before forming their business. More often than not, small business owners choose to form an LLC first instead of a corporation simply due to the increased flexibility of operating an LLC, as well as the reduced formalities. Thereafter, once the LLC has established its credibility and obtains financial stability, the LLC might want to convert to a corporation. Unlike an LLC or C corporation, an S corporation is not an actually type of business structure. Instead, it is an election that some corporations take for tax purposes.

Advantages of an LLC

There are many advantages to operating as an LLC. Some of the greatest benefits include the following:

  • LLCs need not file a corporate tax return for the LLC, as all profits and losses pass through to the owners who report it on their personal tax returns
  • Forming an LLC is easy and straightforward, requiring fewer formalities than corporations
  • LLCs are cheap to form, as the cost totals approximately a few hundred dollars
  • The guidelines for ongoing upkeep of your LLC aren’t as tedious as a corporation, and therefore, the LLC could save money on what a corporation might otherwise have to pay for the services of a lawyer or accountant
  • LLC members benefit from limited liability protection

Disadvantages of an LLC

While there are many advantages to operating an LLC, there are some disadvantages too. Particularly, single-member LLC owners have to pay self-employment tax on any income they receive from the LLC. This also means they are required to make quarterly payments to the IRS. Owners of the LLC also could be held personally liable under certain circumstances; therefore, the personal liability protection doesn’t always work. If this does occur, then it is known as “piercing the corporate veil.”

Some potential instances of when the corporate veil could be pierced is if the LLC owner engages in illegal or fraudulent acts, personally guarantees a loan, acts recklessly by obtaining financing knowing that the loan couldn’t be paid back, or treats the LLC as an extension of oneself.

Advantages and Disadvantages of an S Corp

Some of the many advantages to operating as an S corp include tax benefits for excess profits, as all S corp owner-employees must be paid a reasonable salary subject to payroll taxes. But any remaining profits left over can be distributed to the owners in the form of dividends, which aren’t taxed. Similar to the LLC, the S corp is treated as a pass-through tax entity.

There are some disadvantages to the S corp, particularly when it comes to S corp ownership. As such, some of these restrictions include the following:

  • S corp owner/shareholders must be U.S. citizens or permanent residents
  • No more than 100 shareholders
  • Only one class of stock is allowed
  • Profits/losses must be distributed to the shareholders based on the portion of the shareholder’s interest, i.e. 60% owner must pay taxes on 60% of the business profits

There are also some additional disadvantages to operating an S corp, including the fact that it costs more money to form an S corp than it does an LLC. Furthermore, there are additional formalities placed on the S corp, similar to that of a C corp. Specifically, the S corp must hold periodic meetings for the shareholders and board of directors, while keeping meeting minutes of such meetings.

The S Corp also has a passive income limitation, meaning that the business can have no more than 25% of gross receipts from passive income. An example of passive income is a real estate investment. The S Corp might also have greater tax implications, as a lot of states charge additional state taxes on S corps.

The IRS generally keeps a closer eye on S corps due to the reasonable compensation requirement. Since shareholder-employees must be paid a reasonable compensation, the shareholders must ensure that they are not strictly receiving compensation through dividends, which aren’t taxed. Otherwise, the IRS will assume that you are trying to avoid paying taxes.

If you need help learning about the pros and cons of an LLC and S Corp, or whether you should form an LLC or S Corp for your business, 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, Stripe, and Twilio.