Single-Member LLC vs. S Corp: Everything You Need to Know
Limited liability companies and S corporations share several benefits for sole proprietors, including protecting personal assets from business creditors. 3 min read
Updated July 8, 2020:
Choosing between a single-member LLC vs. S corp is a common conundrum for new business owners who are planning to establish a formal entity. Limited liability companies and S corporations share several benefits for sole proprietors, including protecting personal assets from business creditors. Your financial investment in the business is the limit of your liability.
These entities also share an advantageous tax structure that allows them to avoid the double taxation that affects corporations. With an LLC, profits and losses are reported on the owner's individual tax return, while in an S corp, the owner is paid a salary for his or her work and receives additional profits as dividends.
Both types of business can deduct expenses before taxes, including those for uniforms, travel, phone and internet, computers, promotion, advertising, cars, gifts, and health care premiums.
LLC and S Corp Definitions
By default, a single-member LLC (SMLLC) is treated as a disregarded entity by the IRS. However, the member can opt to instead be taxed as a C or S corporation to avoid self-employment taxes.
An S corporation is a special corporate designation that also enjoys pass-through taxation and avoids corporate income tax. An S corporation is not a type of business entity but a tax status with the IRS.
S corporations are required to follow formalities such as issuing stock, creating and adopting bylaws, holding annual shareholder and director meetings, and keeping official records of meeting minutes. LLCs are recommended but not required to create an operating agreement, issue shares to members, hold and document annual manager and member meetings, and keep records of major company decisions.
An LLC can be run by its members or by managers hired by the members. An S corporation is managed by a board of directors elected by shareholders, which in turn elects officers for day-to-day business administration.
In some states, LLCs must list a dissolution date in their formation documents, while S corps always enjoy perpetual existence.
S corp stock can be freely transferred, while LLCs usually require approval from other members to transfer ownership stakes.
LLC Benefits and Disadvantages
Pros of establishing a single-member LLC include:
- The ability to avoid double taxation
- Easy setup, typically involving only a one-page form
- Inexpensive setup cost averaging a few hundred dollars
- Fewer state requirements than corporations, such as filings and meetings
Potential negatives of this business entity include:
- Subject to self-employment tax and quarterly IRS payments for LLC income
- The need to fully separate business and personal affairs to protect limited liability
An LLC can also opt for S corporation tax treatment while retaining its LLC structure.
S Corporation Benefits and Disadvantages
Pros of an S corp include:
- Tax advantages when distributing excess profits to owners
- The ability to pay employees a reasonable salary and deduct taxes and other payroll expenses
However, potential disadvantages include:
- Stricter state requirements than LLCs
- Higher formation costs
- Passive income limitation of 25 percent of gross receipts, including investment in real estate
- Possible higher state taxes
- Increasing IRS scrutiny of salary structures
The state requirements for S corporations include a limit of 100 shareholders, all of whom must be U.S. citizens or permanent residents. This entity can only offer one stock class. Shareholder distributions must be made proportionally to their interest stake in the company.
This structure is best suited for fast-growing businesses and those that plan to attract additional investors and shareholders.
How to Elect S Corp Status
An LLC or C corporation can elect to be treated as an S corp by the IRS by filing Form 2553, Election by a Small Business Corporation. This can be done at any time after establishing the business entity but must become effective within 75 days before you file the form or within 12 months after filing. S corporations must annually complete IRS Form 1120S, Income Tax Return for an S Corporation.
Most companies that choose S corp status do so to reduce self-employment taxes while retaining pass-through taxation. You receive a salary from the corporation and are not considered self-employed. Profits beyond your salary are taken as dividends, which are not subject to corporate income or employment-related taxes. However, you must make sure that you take a reasonable salary before dividends are distributed.
Your business is not eligible for S corp election if it is foreign, owned by a non-resident alien, or owned by a partnership or corporation.
If you need help with deciding what type of entity is the best choice 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, Menlo Ventures, and Airbnb.