Congratulations on starting your own business! Before we get to the exciting bit, running your business and making your fortune, there is some admin to take care of. You’ll have to choose what sort of legal structure you would like your business to take. In this article we’ll give you the low down on the difference between LLCs and S Corps, so you can decide which of these is a better fit for your business.
What is an S Corp?
If you decide to file your business as an S corporation, you’ll be able to enjoy the benefits of a corporation while being taxed as a partnership. An S Corp passes income directly to shareholders and avoids double taxation.
To file as an S Corp your business needs to have 100 shareholders or less, be completely American owned and operated, and should only have one class of stock.
One of the key advantages of filing as an S corporation is that the company will not have to pay federal taxes at the entity level. This can help save the company money, which is helpful when your business is just starting out.
What is an LLC?
LLC stands for Limited Liability Company. The exact legal definition of an LLC will vary from state to state but basically, an LLC is a business entity that is legally separate from its owners. Like with an S Corp, the profits of an LLC pass through the taxes of the owner and not the company. This means that the owner is not personally liable for the company’s debts and legal liabilities.
It is important as an LLC that you have a business bank account that is separate from your personal account. This account should be accessible to all business owners.
What is the Difference Between an LLC and an S Corp?
What Are the Similarities Between an LLC and an S Corp?
Before we dive into how an LLC and S Corp are different, let’s start with their similarities. First of all, both an LLC and an S Corp establish you and your business as separate entities. This offers protection for your personal assets. Both of these business structures also offer the ability for you to be exempt from taxation when you are filing business taxes. LLCs and S Corps are regulated by certain state compliance rules, these can vary depending on the state.
What Are the Differences Between an LLC and an S Corp?
Now that we’ve looked at some of the ways LLCs and S Corps are similar, let’s explore some of the key differences.
One of the reasons people choose to file as an LLC is because it is much more flexible when it comes to ownership. An S Corp is restricted to 100 owners or less. All S Corp owners have to be U.S citizens or permanent residents. In comparison, there are no ownership restrictions with an LLC.
Length of Structure’s Existence:
With an S Corp, if the original owner passes away, ownership can be transferred to an heir. With an LLC, existence is limited. Typically, the business would be dissolved if the owner passes, or goes bankrupt. The business would have to be reregistered with a new owner.
Another difference between an S Corp and LLC is how the owners and employees are paid. With an S Corp owners are employees and receive a salary with payroll. LLC owners take portions of profits, which doesn’t withhold income tax.
With an S Corp, owners would file a Form 1120S tax form. With an LLC, owners would file Schedule C, Form 1065, Form 1120S, Form 1120, depending on the number of owners.
S Corps and LLC also operate differently. S Corps operate according to bylaws. Typically, governed by shareholders and day-to-day operations are managed by elected officers. With an S Corp there is usually a Board of Directors that holds regular meetings to make strategic decisions. Once again, LLCs tend to be more flexible than S Corps. They operate according to what the owners have agreed on as part of an ‘operating agreement’. Owners manage the day-to-day decisions or, if they prefer, can have this done by an elected manager or director.
Should Your Business Be an LLC or an S Corp?
Now that we’ve broken down the similarities and differences between an LLC and an S Corp, it’s time to decide which is the best option for your business. To help you do this, we’ll be breaking down the pros and cons of each business structure.
Pros: Reasons Why You Should Become an S Corp
One of the biggest attractions of an S Corp are the tax benefits. The profits and losses of the business pass through the business owners, allowing them to avoid double taxation. S Corps don’t pay corporate income tax. Shareholders split up income and report it on their personal tax return.
Cons: Limits of Becoming an S Corp
The biggest con of an S Corp, when compared to an LLC, is the lack of flexibility in how the business operates. S Corporations must follow strict operating guidelines. They cannot exceed 100 owners or shareholders all of which need to be U.S citizens or permanent residents. It is also worth keeping in mind that it can be costly to file as an S Corp.
Pros: Reasons Why You Should Become an LLC
There are many LLC banking benefits. Generally speaking, LLCs are more flexible and simpler to set up than S Corps. The guidelines for how they operate are less strict so you can organize the business in a way that best suits you as a business owner. They are also cheaper to file and register for than an S Corp. If there is only one owner of the LLC, they don’t need to file a tax return for their business. Instead, they just fill out a personal tax return.
Cons: Limits of Becoming an LLC
While there are plenty of benefits to registering your business as an LLC, it’s important to note that it does require you to pay special attention to your bookkeeping. If you are the sole owner of your LLC, you’ll need to pay self-employment tax on an income from the business. You’ll also need to provide a quarterly income statement to the IRS. There are plenty of business tools out there that can help you stay on top of your bookkeeping and accounting, we recommend this is something you look into if you are registering as an LLC. Make sure your personal and business affairs are entirely separate to protect yourself against liability.
S Corporation vs. LLC: A Final Overview
If you are looking for a business structure that is going to offer you and your business partners the best tax benefits, an S Corp might be the way to go. If you are looking for something that offers you flexibility in the way your business is managed, with less record-keeping obligations, an LLC might be the business structure for you.
Whatever way you choose to structure your business, it is important that you keep you business and personal finances separate. NorthOne’s business bank accounts offer more than just a place to store your business profits. The app also includes a variety of built-in features that will make managing your business a breeze.