Which corporate structure is right for your business? You might already be familiar with the terms “limited liability company” (LLC) and “S corporation” (S corp). But what are the differences between these two business structures, and what do these differences mean for businesses?
LLCs and S corps are two of the most common business entities in the US. With so many entrepreneurs opting for one of these two structures, it’s important to understand the distinctions between LLCs and S corps in order to choose the best fit for your business.
Here’s a detailed explanation of the key differences between LLCs and S corps, including what you need to know to decide which structure is right for you.
What’s in this article?
- What is an LLC?
- What is an S corp?
- What is the difference between an S corp and an LLC?
- Can an LLC be an S corp?
- Can an S corp own an LLC?
- What are the benefits and drawbacks of LLCs vs. S corps?
- How to choose between an LLC and an S corp
What is an LLC?
LLC stands for “limited liability company.” It’s a type of business entity that combines the limited liability protection of a corporation with the flexibility and tax benefits of a partnership. Forming an LLC establishes a business as a separate legal entity from its owners, who are called members, meaning they are not personally responsible for the debts and obligations of the business. This legal distinction offers the owners greater protection.
LLCs can be taxed as either a corporation or a pass-through entity, in which profits and losses are passed through to the members’ personal tax returns.
What is an S corp?
An S corporation (S corp) is a type of business structure that is typically more appropriate for small and medium-sized businesses that want to avoid the double taxation that can occur with a traditional corporation.
In an S corp, the company’s income and deductions pass through to the shareholders’ personal tax returns, and the company itself does not pay federal income tax. This means that the shareholders of the S corp are only taxed once on the company’s profits—rather than twice, as a company and as shareholders.
To be eligible for S corp status, a business must meet certain requirements, such as having no more than 100 shareholders and being organized as a domestic corporation. S corps are a popular choice for businesses that want the liability protection of a corporation but prefer to be taxed like a partnership or sole proprietorship.
What is the difference between an S corp and an LLC?
While both S corporations and LLCs provide limited liability protection to their owners and offer flexibility in taxation and management structure, there are key differences between the two. Ultimately, the choice of whether to organize as an S corporation or an LLC depends on the specific needs and goals of the business owners. Here’s an overview of the key differences between these two options:
The biggest difference between S corporations and LLCs is how they are taxed. S corporations are taxed as pass-through entities, meaning that the profits and losses are passed through to the shareholders’ personal tax returns, while LLCs can choose to be taxed as either a pass-through entity or a corporation.
S corporations have restrictions on who can be a shareholder, as well as limits on the total number of shareholders (no more than 100, and they must be either US citizens or residents). LLCs have no such restrictions. Additionally, S corporations can issue only one class of stock, while LLCs can have multiple classes of ownership interests.
LLCs offer more flexibility around management structure, since they can be managed either by the owners (“member managed”) or by a designated manager (“manager managed”). S corporations are required to have a board of directors and officers.
S corporations generally have more formalities and reporting requirements compared to LLCs, such as needing to hold regular meetings and maintain corporate records.
Can an LLC be an S corp?
Yes, an LLC can elect to be taxed as an S corp, which allows it to benefit from the pass-through taxation that S corps enjoy while maintaining the flexibility and limited liability protection of an LLC. To qualify for S corp taxation, the LLC must meet certain requirements, including having no more than 100 shareholders (all of whom are US citizens or residents), having only one class of stock, and meeting certain restrictions on the types of shareholders and types of stock that can be issued.
While an LLC can elect to be taxed as an S corp, it’s still classified as an LLC under state law and must comply with all the requirements and regulations governing LLCs in the state where it’s registered. On top of adhering to the requirements for LLCs, companies that opt for S corp taxation might also have to follow additional regulations and requirements of S corps. It can get complicated, which is why it’s important to work with a tax attorney and accountant to be sure your business is making the appropriate tax elections and fulfilling all associated requirements.
Can an S corp own an LLC?
Yes, an S corp can own shares in other corporations or own interests in other types of businesses, including LLCs. If an S corp owns an LLC, the LLC is considered to be a separate legal entity, and the S corp’s ownership interest in the LLC is treated as an asset of the S corp. The S corp will report its ownership interest in the LLC on its tax return, and any income or losses generated by the LLC will flow through to the S corp and be reported on the S corp’s tax return.
In this scenario, the S corp would be considered the parent company or holding company of the LLC, and the LLC would be a subsidiary or wholly owned subsidiary of the S corp. The S corp would have the power to make decisions and take actions on behalf of the LLC, as well as the responsibility for any liabilities or debts incurred by the LLC.
What are the benefits and drawbacks of LLCs vs. S corps?
Both LLCs and S corporations offer advantages and drawbacks, depending on the specific needs of the business. Here are some of the pros and cons of each structure:
Benefits of an LLC
LLCs offer flexibility in terms of ownership, management structure, and tax status. They can be owned by one or more people, can be managed by the owners or by a designated manager, and can be taxed either as a pass-through entity or a corporation.
Like an S corp, LLCs provide limited liability protection to their owners, meaning that the personal assets of the owners are generally not at risk for the debts and liabilities of the business.
LLCs generally have fewer formalities and reporting requirements than S corps, which can make them easier—and less expensive—to manage.
Drawbacks of an LLC
LLC owners must pay self-employment taxes on all profits, which can be higher than the taxes paid by S corp shareholders.
In some states, LLCs have a limited lifespan and may need to be dissolved after a certain period of time or after a specific event, such as the death of an owner.
Limited access to capital
Compared to S corps, LLCs may have limited options for raising capital, such as through stock offerings or taking on investors.
Benefits of an S corp
S corps are taxed as pass-through entities, meaning that the profits and losses are passed through to the shareholders’ personal tax returns, potentially resulting in lower overall taxes.
S corp owners can avoid some self-employment taxes by paying themselves a salary and accessing additional profits as distributions, which are not subject to self-employment taxes.
S corps have restrictions on who can be a shareholder and how many shareholders the corporation can have, which can make this structure attractive to smaller businesses that want to limit the number of owners.
Drawbacks of an S corp
S corps must hold regular meetings, maintain detailed records, and follow other formalities to maintain their status.
Limited ownership options
S corps cannot have more than 100 shareholders, who must be individuals or certain types of trusts.
S corps must meet certain eligibility requirements, such as having an owner who is a US citizen or resident alien.
How to choose between an LLC and an S corp
Think through your specific needs related to ownership structure, management preferences, taxation, liability protection, and business objectives. Consider the business as a whole, the long-term trajectory you hope it follows, and which aspects of each structure feel the most important to you, as an owner. The decision is both logical and subjective—which is why it can be such a difficult one to make.
Here are steps to consider taking when choosing between an LLC and an S corporation:
Evaluate your business needs
Consider the type of business you run, the number of owners or shareholders you have, the industry you operate in, and your long-term goals for the business.
Understand the tax implications
Compare the tax advantages and disadvantages of each structure, including pass-through taxation for LLCs and S corps, self-employment taxes for LLCs, and the potential for tax savings with S corps. There are benefits and drawbacks with either option, so the specifics of your business will dictate which is right for you.
Consider liability protection
Both LLCs and S corps offer limited liability protection for owners, but LLCs may provide more flexibility in terms of personal asset protection—especially if the business has multiple owners.
Compare management structures
Think about the level of management control and flexibility you need, including whether you want to be actively involved in running the business or prefer to hire a designated manager.
Understand the compliance requirements
Both LLCs and S corps have specific requirements that must be met, including rules about filing paperwork, holding regular meetings, and maintaining accurate records. Consider the time and resources needed to comply with these regulations.
Seek professional advice
Whether or not you think you know which entity makes the most sense for your business, it’s a good idea to talk to an expert before moving forward. Consult with a qualified attorney or accountant who can help you understand the legal and tax implications of each structure and help you make an informed decision based on your specific business needs.
How Stripe can help
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The Stripe Atlas application
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Filing your 83(b) tax election
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Partner perks and discounts
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