TABLE OF CONTENTS
When determining your organization’s business structure, it’s important to consider the tax rules, formation costs, regulations, and ownership options.
S Corporations (S Corps) and Limited Liability Companies (LLCs) are two of the most popular business structures. We’ll go over the definitions of each structure, the main differences, the pros and cons, and the steps to form these structures as you start your new business.
What Is an S Corporation?
An S Corporation, a type of corporation structure, is a legal entity that shields its owners from liability, which means its owners can reduce exposure to legal actions against their business. It can have up to 100 owners, all of whom must be US residents.
An S Corp allows for pass-through taxation, meaning the business’s owners can pay tax at their personal income tax rates. This type of business structure also allows its owners to steer clear of self-employment tax when paying dividends.
However, while an S Corp allows its owners to save money on self-employment tax, they have strict regulations and reporting requirements. S Corps must have a board, host annual meetings, and record minutes of these meetings.
What Is an LLC?
A Limited Liability Company is a business structure that limits liability for its owners. Setting up an LLC can help protect you from debts, legal actions against your business, and other potential liabilities. Owners of an LLC are typically taxed using pass-through taxation, which means its owners can attribute profits and losses to their personal tax returns.
This helps LLC members avoid paying both corporate and personal tax on earnings. For this reason, it’s a popular business structure for business owners that are seeking a setup similar to sole proprietorships or partnerships.
What Are the Similarities and Differences Between an LLC and an S Corp?
To gain a deeper understanding of LLCs and S Corps, below is an overview of the core differences and similarities between these business structures:
LLCs and S Corps can conduct business in a similar fashion. While their ownership, management structure, and tax status will vary, they can provide similar goods and services within the United States.
In terms of ownership, an LLC can have unlimited owners and these owners can be from anywhere in the world. In many cases, LLCs have single owners and operate sole proprietorships, but they can have many owners and act as partnerships.
On the other hand, an S Corp’s owners must reside inside the United States. There is a maximum of 100 owners allowed for an S Corp.
S Corporations must have a board of directors.Forbes. “Should I Have A Single-Person S-Corporation?” Accessed April 19, 2022. These boards can put officers in place for the management of the company.
LLCs do not require boards, so they’re overseen by managers. These managers can be the LLC’s owners, or the LLC can elect to hire managers to run the company.
Stock and shareholder roles
LLCs cannot issue stock, making it a business structure to not use for investments. Likewise, LLCs that register for the S Corporation classification are also unable to issue stock.
On the other hand, an S Corp can issue stock but it can only be common stock, which entitles the shareholders to have voting rights.
In addition to its tax advantages, an S Corp is economically easy to set up. You can expect to pay between $100 and $250 to incorporate a new S Corporation.
LLCs are also affordable, but they can cost more than an S Corp in some states. While the starting price for incorporating an LLC is around $50, the price of incorporation can reach up to $500 depending on the state.
It’s essential to remember the upkeep costs for an S Corp. It is required to maintain a company board, and conform to regulations. For these reasons, the costs associated with an S Corp can be higher in the long run.
Both an S Corp and LLC allow for pass-through taxation. Similar to sole proprietorships, LLC members must pay a 15.3 percent self-employment tax on their earnings.
S Corps eliminate some exposure to self-employment tax and allow owners to pay themselves in a mixture of salary and dividends, making this an attractive option for entrepreneurs who wish to lower taxes. Self-employment tax is not payable on S Corp dividends.
Is an LLC taxed as an S Corp?
An LLC is not automatically taxed as an S Corp. LLCs are traditionally taxed in the same manner as a sole proprietorship, which means they incur self-employment tax. However, an LLC can apply to be taxed as an S Corp with additional regulations required.
Pros and Cons of an S Corporation vs LLC
There is no easier way to compare an S Corp and an LLC than a pros and cons list. Below, let’s take a deep dive into the advantages and disadvantages of LLCs and S Corps:
- Easy setup: LLCs are easy to set up since you won’t have to form a board or apply for a special tax status. Costs for setup will vary depending on your state.
- Low reporting standards: The low reporting standards for LLCs make it easy to file taxes, pay yourself, and benefit from being a business owner without an administrative team.
- Limited liability: An LLC provides liability protection that is suitable for a business owner that wants to separate their personal from their business liabilities.
- Simple ownership guidelines: LLCs can have unlimited members and it is not required for these members to be US residents.
- Self-employment tax: You have to pay a 15.3 percent, self-employment tax on your earnings, which is a high cost.
- Pay personal income tax rates: The business’s profits or losses will be attributed directly to your personal income.
S Corp pros
- Limited liability: S Corp offers limited liability protection the same way an LLC does.
- Dividends: S Corps can pay dividends to employees, reducing exposure to self-employment tax and saving a significant amount of money.
- Pass-through taxation: S Corps also allow pass-through taxation preventing S Corps from being taxed at a corporate level.
- Issue stock: Unlike LLCs, S Corps can issue stock. This makes it easier to seek an outside investment with an S Corp.
S Corp cons
- State laws can vary: Some states may choose to tax S Corps at a corporate level therefore, you will want to check with your state’s tax regulations surrounding S Corps.
- Stricter regulations and reporting standards: S Corps must maintain boards and adhere to a range of reporting standards that can be costly, complex, and time-consuming.
- Strict ownership rules: Owners must be US residents and there is a maximum of 100 owners for S Corps.
How to Choose an S Corp vs LLC: Which Is Best for Your Business?
Choosing the best business structure will depend on your ownership structure, tax needs, and other critical factors.
For example, if you have a business with owners oversea, then an S Corp will not be an option. Additionally, if you don’t want to maintain a board, record minutes, and adhere to other guidelines, then an LLC is a better choice. Forming an LLC is the most simple and convenient way to limit liability for yourself.
However, if you want to eliminate your exposure to self-employment tax, as well as receive your income in a combination of salary and dividends, then an S Corp is preferable. An S Corp is also attractive for those looking to gain investment. On the other hand, this will also result in more requirements and record-keeping.
How to Form an LLC vs S Corp
Once you’ve decided which business structure is best, you will need to start building it. Below you’ll see the requirements to form an LLC or an S Corp:
Forming an LLC
You can start an LLC by following these simple steps:
- Choose a business name and designate a registered agent to accept legal documents on behalf of your business.
- File the articles of organization with the local Secretary of State and include an overview of your business.
- Produce an operating agreement outlining profit distribution, management structure, and other details regarding the operations of your LLC.
- Apply for an EIN or federal tax ID number with the IRS to identify your business.
- Obtain required permits and licenses for your region and business’s industry.
- Open a business bank account to keep personal and business finances separate. You may even consider an online business account provider or a local credit union.
Forming an S Corp
To form an S Corp, similar steps would need to be followed besides a few minor differences:
- Choose a business name that is unique and does not resemble another business’s name.
- Compile your board of directors and record the minutes at routine board meetings.
- File the articles of organization and include information regarding ownership, contact information, share allocations, and other details required by your state.
- File your business’s corporate bylaws with the Secretary of State.
- Head to the IRS website to file Form 2553 after the Secretary of State receives your articles of organization.
- File your business with a registered agent to handle the legal documentation on your behalf.
- Open a business bank account to keep personal finances separate from your S Corp finances.
Can I convert my LLC to an S Corp?
Yes. While you can always convert your business structure at a later date, this can be both complex and costly. In some cases, you may have to pay tax penalties to shift your LLC into an S Corp. The potential costs are why it’s always best to choose the correct business structure before beginning your operations.
S Corp vs LLC: FAQs
We receive a lot of questions about business structures. Below are some standard questions about the differences between S Corps and LLCs:
Will I pay less in taxes with an LLC or S Corp?
This depends on your individual tax situation. However, in most cases, an S Corp can be useful for saving money on taxes. This is because S Corp owners do not have to pay a self-employment tax of 15.3 percent on dividends, which can save plenty of money. LLCs are typically taxed the same as sole proprietorships.
How do I pay myself from an LLC compared to an S Corp?
As an LLC owner, you can pay yourself directly from your business’s revenue. This is traditional income and is treated as such – however, you will need to pay self-employment tax on your LLC income in addition to personal income tax.
On the other hand, an S Corp allows its owners to distribute money in dividends. As dividends can carry lower tax rates, S Corp owners are also required to draw a reasonable salary from their business. While a reasonable salary lacks a clear definition, many accountants treat it as 60 percent salary and 40 percent dividends.PicnicTax. “How to Pay Yourself from an S Corp, LLC or Other Small Business.” Accessed April 19, 2022.
Can an LLC be an S Corp?
An LLC can be taxed as an S Corp, but this will mean the LLC has to follow stricter regulations and it will not benefit from the same benefits as a standard LLC.
Is an S Corp or LLC better for owning real estate?
While the answer to this question can vary depending on your real estate investments, LLCs are easier for transferring property. If you transfer real estate in or out of an S Corp, it can result in significant tax consequences.UpCounsel Technologies, Inc. “LLC or S Corp for Rental Property: Everything to Know.” Accessed on April 19, 2022.
Will an LLC and S Corp use the same business insurance?
Both LLCs and S Corps will protect an owner’s personal liability but business insurance will help with the financial costs you may see if a liability claim were to arise. In general, you will want to have your business insurance include general liability insurance and professional liability insurance.
General liability insurance will protect your business against claims from bodily injury, property damage, and advertising injury. Professional liability insurance will protect you from a client filing a lawsuit against you for making a mistake in the service that was given. To protect yourself from professional liability, you might even want to consider forming a PLLC.
It is best to choose specific policies for your business insurance that are customized to your business operations.
Will my DBA name be okay if I choose to form an S Corp?
Some states require that “LLC” be included in your business name however, this is not the case with S Corps. The only requirement is that your business name is unique and not be same as another registered business name.
What Is Better for a Small Business LLC or Corporation? Closing Thoughts
As a small business, you may not have the bandwidth to keep up with proper regulations and simplicity is what you look for. Small business owners typically gravitate towards LLCs due to not needing to create a board of members and adhere to strict laws. While you can always change your business structure, making the right choice can save you time and money. Also, start-up costs are fairly low and suitable for first-time entrepreneurs.
Although you can change your business structure at any time, you will want to choose the right one to avoid costly penalties and barriers to accepting payments for your business.
- Forbes. “Should I Have A Single-Person S-Corporation?” Accessed April 19, 2022.
- PicnicTax. “How to Pay Yourself from an S Corp, LLC or Other Small Business.” Accessed April 19, 2022.
- UpCounsel Technologies, Inc. “LLC or S Corp for Rental Property: Everything to Know.” Accessed on April 19, 2022.