What's the Difference Between an LLC and an S Corp?

Difference Between an LLC and an S Corp

Both Limited Liability Companies (LLCs) and S Corporations (S Corps) are popular business structures that provide liability protection to their owners. However, they have distinct characteristics, advantages, and disadvantages. Here’s a breakdown of the key differences:

1. Formation

• LLC: Formed by filing Articles of Organization with the state. It is generally easier and less formal to set up.

• S Corp: Formed by filing Articles of Incorporation and then electing S Corporation status with the IRS. This process is more complex and requires adherence to specific regulations.

2. Ownership

• LLC: Can have an unlimited number of members, who can be individuals, corporations, or other LLCs. There are no restrictions on ownership.

• S Corp: Limited to 100 shareholders, who must be U.S. citizens or residents. Only individuals can be shareholders; other corporations or LLCs cannot own shares.

3. Taxation

• LLC: Typically treated as a pass-through entity for tax purposes, meaning profits and losses are reported on the owners' personal tax returns. An LLC can also opt to be taxed as a corporation.

• S Corp: Also a pass-through entity, but must meet specific IRS requirements. Income is reported on shareholders' personal tax returns, avoiding double taxation.

4. Self-Employment Taxes

• LLC: Members may be subject to self-employment taxes on the entire income of the business.

• S Corp: Shareholders who work for the company must be paid a reasonable salary, which is subject to payroll taxes, while remaining profits can be distributed as dividends, potentially reducing self-employment tax liability.

5. Formalities and Compliance

• LLC: Generally has fewer formal requirements. Minimal record-keeping and reporting are needed.

• S Corp: Must adhere to more formalities, such as holding annual meetings, maintaining minutes, and filing specific documents with the state and IRS.

6. Flexibility in Management

• LLC: Offers flexibility in management structures; members can manage the business directly or appoint managers.

• S Corp: Must have a board of directors and follow a more structured management format.

7. Profit Distribution

• LLC: Members can distribute profits in any manner they choose, regardless of ownership percentage.

• S Corp: Profits must be distributed according to the number of shares owned by each shareholder.

In summary, the choice between an LLC and an S Corp depends on various factors including the desired level of formality, tax implications, and the nature of the business. It is advisable to consult with a legal or financial professional to determine the best structure for your specific situation.