Both LLCs and S-Corporations are popular business structures, but they have distinct characteristics that can significantly impact your business operations and tax situation. Let's explore the main differences between these two business entities.
An LLC (Limited Liability Company) is a flexible business structure that combines the personal liability protection of a corporation with the tax benefits of a partnership. It's generally simpler to form and maintain than an S-Corporation.
An S-Corporation is actually a tax classification, not a business structure. It's a corporation that has elected to be taxed under Subchapter S of the Internal Revenue Code. This means the business itself doesn't pay federal income taxes. Instead, the income passes through to the shareholders.
LLCs typically require less paperwork and fewer formalities. You'll need to file articles of organization with your state and create an operating agreement, but ongoing requirements are usually minimal.
S-Corporations require more rigorous record-keeping. You must file articles of incorporation, hold regular board meetings, keep detailed minutes, and maintain strict corporate records. There are also more specific rules about ownership – S-Corporations are limited to 100 shareholders, and all must be U.S. citizens or residents.
LLCs have flexibility in how they're taxed. By default, single-member LLCs are treated as sole proprietorships, and multi-member LLCs are treated as partnerships. However, LLCs can elect to be taxed as corporations if desired.
S-Corporations provide a unique tax advantage: owners can be both employees and shareholders. This means they can receive both a reasonable salary (subject to employment taxes) and distributions (not subject to self-employment tax), potentially reducing their overall tax burden.
LLC members typically pay self-employment tax on all business income.
S-Corporation shareholders-employees only pay employment taxes on their salary, not on distributions. However, the IRS requires that shareholders who work in the business receive a "reasonable" salary before taking distributions.
Consider an LLC if you: