Pros and Cons of LLC vs S Corp: Everything You Need to Know
Pros and cons of an LLC vs. an S Corp are important to know to help decide which business structure works best for you.3 min read
Pros and cons of an LLC vs. an S Corp are important to know to help decide which business structure works best for you. A limited liability company (LLC) is a legally separate entity from its owners, known as members. An S corporation is not a type of business entity. It refers to the chosen method the business wants to be taxed by the Internal Revenue Service.
Pros and Cons of an LLC
- An advantage of an LLC is the option to have one or many members.
- An LLC is often chosen over an S corporation because of its flexibility in the management of day to day operations, especially with less recordkeeping and less reporting obligations than those required of a corporation.
- An LLC is considered a hybrid business structure, as it blends partnership and corporation attributes.
- For tax purposes, an LLC combines the benefits of limited liabilities and pass-through taxation, which is similar to an S corporation.
- The LLC business structure is not as restrictive as an S corporation, which is attractive to business owners.
- An LLC is easy to set up and maintain.
- To set up and register an LLC, you must file the form for articles of organization with your state. You must also publish a notice of the limited liability company's formation in your local newspaper.
- It is advisable to create an operating agreement. Though not required, the operating agreement includes pertinent information about the LLC, such as member's rights and percentage of interest and information on profits and losses of the business. It is also used to outline the regulations and operational procedures of the organization.
- To form an LLC, you must register a trade name if using a name other than your own and obtain any state or local permits that may be required.
Pros and Cons of an S Corporation
- An S Corporation gets its designation from Subchapter S of the IRS Code. Under Subchapter S, an S Corporation's shareholders may receive all the company profits directly. The shareholders are then responsible for paying taxes on the income received.
- S Corporations are not subject to double taxation. The business is not taxed but shareholders are as long as they have received fair market value.
- From the investor point of view, the corporate structure seems to be more permanent than the structure of a limited liability company.
- Corporations have the advantage of selling stocks when there is a need to raise capital.
- A disadvantage is there is a limit on issuing shares in some situations.
- An S corporation has strict rules for keeping the business compliant, as well as who is eligible to vote on corporate matters.
- Advantages of an S corporation include the protection from personal liability and the pass-through profits from the company go to the owners to file on personal tax returns.
S Corporation vs. LLC Tax Benefits
- The IRS classifies businesses as C corporations, S corporations, sole proprietorships, and partnerships.
- Since there is no tax classification for LLCs, they are taxed as though they are another type of business. For single-member LLCs, the IRS taxes the business as a sole proprietorship. For multi-member LLCs, the IRS taxes it as a partnership.
- An LLC can choose to be taxed as either an S corporation or a C corporation.
- Another difference for small businesses is the way owners pay Social Security and Medicare, which are considered self-employment taxes. An LLC can save money on these taxes if the owner opts to be taxed as an S corporation.
- If a single-member LLC chooses to be taxed as an S corporation, the member can be considered an employee.
- A reasonable salary must be paid to the owner/employee.
- In this situation, the LLC reports the employee salary as a business expense. The owner/employee will report the salary and any remaining profit from the business on their tax return.
- For an S corporation owner, taxes are paid only on his or her salary. The remaining profits of the corporation are not subject to taxes.
- Not every business qualifies to be taxed by the IRS as an S corporation. In most cases, a single-member LLC will qualify. If any of the following apply to a single-member LLC, it will not qualify: the limited liability company is a foreign business, the owner is a nonresident alien, or the business owner is considered a partnership or corporation.
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