S Corp vs. LLC: What’s the Difference and Which One Is the Best Fit for Your Business?
Eytan Bensoussan
6 min read
When it comes to choosing a business structure, we often hear LLC and S Corp in the same conversation. However, it’s not an either-or choice. An LLC, or Limited Liability Company, is a legal business structure, while an S Corp is a tax qualification. In this article, we’ll break down the key differences between an S Corp vs LLC so you can make an informed choice for your small business.
What is an S Corp?
An S Corp is a tax classification that’s available to some small businesses. If you choose to file as an S Corp, you’ll reap the operational benefits of being a corporation and the tax benefits of a partnership. It’s the best of both worlds.
To become an S Corp, your business must first register as a C Corp or an LLC. Then, there are specific guidelines laid out by the Internal Revenue Service (IRS) that must be met to qualify as an S Corp. These include having 100 shareholders or less, being American owned and operated, and having just one class of stock.
What is an LLC?
An LLC is a legal designation that’s used when forming a business. Because an LLC is considered a separate entity, it can protect small business owners from personal liability in business obligations.
The owners of an LLC are called members, and LLCs can be single-member or multiple-member owned.
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?
Both LLCs and S Corps establish your business as a separate entity from yourself. This can protect your personal assets from the company’s debts. Both also offer the ability to avoid double taxation when filing your business taxes.
LLCs and S Corps are regulated by certain state compliance laws, which 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.
- Ownership
An LLC operates much like a sole proprietorship or partnership, but an LLC can have an unlimited number of owners from all over the world. An S Corp, on the other hand, is restricted to 100 owners or less, and they must all be US citizens. This makes owning an LLC much more flexible than an S Corp.
If the owner of an S Corp passes away, ownership can be transferred to an heir. With an LLC, however, existence is limited. Typically, if an owner passes, an LLC would be dissolved and would need to be reregistered under a new owner.
2. 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.
3. Owner pay
Another difference between an S Corp and LLC is how owners are paid. S Corps can employ their owners and pay them a salary, while owners of an LLC take portions of profits, which doesn’t withhold income tax.
4. Tax
An LLC allows the business’s income or losses to pass through the business and are instead recorded on the owner’s personal tax return. This is also known as pass-through taxation. LLCs can also choose to be taxed as a C or S corp if they meet the eligibility requirements.
Similarly, S Corps are not subject to corporate income tax and all profits pass through the company. However, while S Corps file Form 1120S, LLCs should file Schedule C, Form 1065, Form 1120S, or Form 1120, depending on the number of owners.
5. Operation
A corporation, like an S Corp, is governed by a board of directors who make high-level strategic decisions for the business. There is a set of bylaws in place and elected officers who manage the day-to-day operations.
LLCs tend to be more flexible. They’re run by managers according to an “operating agreement”. Owners of an LLC can choose to either participate in management or hire managers to take on that responsibility. Officer roles can also be appointed if it makes sense with the business plan.
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.
Becoming an S Corp
Pros
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, you don’t pay corporate income tax, which means you avoid double taxation. Instead, shareholders split up the income and report it on their personal tax returns. This can save business owners money, which could be a big help if you’re just starting out.
Cons
The biggest disadvantage of S Corps, when compared to LLCs, is the lack of flexibility in how they operate. There are strict operating guidelines to follow, including a limited number of allowed shareholders, restrictions on citizenship, and more. It’s also worth noting that it can be costly to file as an S Corp.
Becoming an LLC
Pros
Generally speaking, LLCs are more flexible and simpler to set up than S Corps. The operating guidelines are more flexible, so you’re free to organize your business in a way that suits your goals and needs. It also tends to be cheaper to file as an LLC vs S Corps. 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. There are also many LLC banking benefits for your business.
Cons
While there are plenty of benefits to 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 any 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, just be sure that your personal and business affairs are kept 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. Knowing what’s the difference between an llc and scorp is essential in making your final decision.
