LLC vs. S-Corp

If you’re starting a business, one critical decision is which type of business entity to form. Limited liability companies (LLCs) and corporations (S-Corp) are two of the most common options. Both offer benefits and disadvantages, laid out for you in this handy guide.

What Is an LLC?

An LLC is a popular business structure for startup companies due to its many benefits. An LLC provides personal liability protection, for example, so that your assets are not at risk if your business is sued or cannot pay its debts. 

Also, an LLC is a “pass-through entity” in taxes, meaning that the LLC itself is not taxed. Instead, income passes through the company to the LLC owners or members, who report it on their tax returns on Schedule C. 

LLCs also offer flexibility in management, as there are few requirements regarding organizational structure. 

What Is a Corporation?

A corporation is a bit more complex than an LLC, with more formal requirements. For example, a board of directors must strategically implement the company’s business plan. 

Shareholders rather than members own a corporation. The ownership is in the form of shares of common stock. Shareholders have ownership of the company but no financial obligations to the company; however, they benefit from the profits of the company.

Unlike LLCs, a corporation pays taxes on the profits of the company. Shareholders also pay taxes on the dividends they receive from the company, which is known as double taxation. 

LLC vs. S-Corp

Let’s compare the elements of an LLC and an S-Corp to see how they are similar and different.

Ownership

LLC owners are called members. Their ownership percentages are defined in an operating agreement, specifying profit and loss distribution and member roles and responsibilities. The operating agreement should also define how ownership is transferred if, for example, a member leaves the LLC. 

The owners of a corporation are shareholders. The number of shares defines their ownership share in the company. They may also receive dividends from company profits.

The shares of a corporation are easily transferred, making a corporation more desirable to investors, who can take partial ownership in the form of shares in exchange for their investment. This is one of the main reasons entrepreneurs choose to form a corporation rather than an LLC. 

Administration

LLCs are easier and less expensive to form than a corporation. Unlike corporations, LLCs are not required to have a board of directors or hold annual meetings. LLCs do, in most states, have to file annual reports. Corporations are more complicated.

Control

In an LLC, the members do not have to answer to anyone. Instead, they fully control the company and can structure the management in any way they choose. In a corporation, on the other hand, managers answer to the board of directors, which has overriding decision-making power. 

Limited Personal Liability

In  LLCs and corporations, owners are considered separate entities from the business, so both structures offer personal liability protection. However, in a few instances, owners do have personal liability. For example, if an owner personally guarantees a bank loan, which is common, they’re liable for that debt. 

Taxes

As mentioned above, LLCs are pass-through entities, which means income passes through to the member or members. If the LLC has only one member, it’s taxed as a sole proprietorship. If the LLC has more than one member, it’s taxed as a partnership. 

However, LLCs are unique because they can elect to be taxed as a corporation if the members decide it makes financial sense. This is done by filing an election form with the IRS. In addition, you can choose to be taxed as a C-Corp or an S-Corp.

For corporations, the business income is taxed at the current rate for corporations (21% as of early 2022), which is lower than the usual individual taxpayer rate. But remember that corporation shareholders must also pay taxes on their distributions. 

However, members are subject to self-employment tax in an LLC taxed by default as a sole proprietorship or partnership. Once such LLC switches to being taxed as a corporation, self-employment taxes no longer apply. 

Similarly, self-employment taxes do not apply to members with S-Corp status, which is the main advantage of electing S-Corp status. 

With S-Corp status, members are generally paid as company employees, which means more accounting and payroll expenses. Therefore, S-Corp status is only beneficial when the self-employment tax savings exceed those additional expenses. 

Profit Sharing

No matter the entity type, most businesses split profits based on owners’ capital contributions. Corporations pay dividends based on the ownership percentage of the shareholders. 

With an LLC, on the other hand, owners can specify in the operating agreement any profit-sharing plan they choose. As a result, one member can take a share of profits greater than their ownership interest, while other owners take less. This may be based on the fact that one member is more involved in day-to-day operations.

Deciding Which Entity Type is Right for Your Business

Many entrepreneurs form an LLC because of its many benefits and simplicity. An LLC is often the best choice if you’re the only business owner, an LLC is often the best choice. If, however, you are in a high-growth industry and plan to raise money from investors soon, a corporation will make your business more attractive to those investors since shares can be easily transferred. 

Usually, small businesses that don’t plan to raise investment capital choose an LLC to avoid the double taxation of a corporation. 

In Closing

Deciding which type of business to form is often done best with the advice of professionals. If you’re unsure which suits you, consult your attorney and tax advisor to weigh your options. You want to get your business off on the right foot by choosing the business entity type that will give you the best chance of success.