What is the Difference Between an LLC and an S-Corporation?

Entrepreneurs have a lot of decisions to make when it comes to how they should classify their business. For most small businesses, choosing between an LLC and an S-Corp is one of the first decisions they need to make. But what is the difference between an LLC and an S-Corporation?

Before we dive in, here are some things you should know up front:

1. While LLC’s are a business entity, an S-Corp is a tax status.
2. An S-Corp election gives business owners a self-employment tax break, so long as they pay themselves a reasonable (taxable) salary, while straight LLC owners must pay self-employment tax on all business income.
3. An LLC can have as many members as they want, while an S-Corp is limited to 100 shareholders.

What is an LLC?

An LLC (Limited Liability Company) is a business entity that protects the owner’s personal assets. This is an important protection if the business gets roped into legal issues or gets sued by a creditor. In that case, only the business assets are at risk, and the owner’s personal assets are protected.

An LLC without any other tax election is taxed as a sole proprietorship. This means that it has the tax advantages of a pass-through entity, meaning that the profits pass through the LLC to the members, and is taxed as part of their personal income. The LLC members are exempt from paying corporate taxes, but will pay self-employment tax on their income.

What is an S-Corp?

Electing to be an S-Corp (S Corporation, or S Subchapter), makes your company taxable as a partnership. This means that your business will not be double taxed as a corporation.

Shareholders (owners) are considered employees of the business and must pay themselves a reasonable salary. All profits, losses, deductions, and credits are taxed at the shareholder level.

The Difference Between an LLC and an S-Corp

While an LLC offers more freedom to business owners than a corporation, understanding how an LLC differs from an S-Corp is extremely important.

Management

Management of an LLC works just like a sole proprietorship if there is only one member, or a partnership of there are two. More than that, and the LLC resembles a corporation, where members are not directly involved in the day-to-day business decisions.

S-Corps, on the other hand, usually have a board of directors and elected officers. The board takes care of the major decision making and corporate formalities, and the elected officers manage the day-to-day business decisions.

Shareholders, Subsidiaries, and Stock

Shareholder structure differs between LLCs and S-Corps. LLCs can have an unlimited number of shareholders, and those shareholders may be U.S. citizens, or non-U.S. citizens. By contrast, S-Corps are limited to 100 shareholders, all of whom must be U.S. citizens.

The availability of subsidiaries is also different. An S-Corp cannot have any subsidiaries, while there are no restrictions on subsidiaries for LLC’s.

Issuing stock is another main point of difference. An S-Corp can grant one kind of stock, while an LLC cannot issue stock.

Taxes

Keep in mind here that an S-Corp is not a business entity. It is an elected tax status. It requires that a company is also an LLC. The main difference between the two, as far as taxes go, is who pays the taxes on profit. In an LLC, the shareholders pay these taxes with their personal annual taxes, as self-employment tax, which are taxes that go into Social Security and Medicare. Any income from the LLC is considered taxable.

An S-Corp functions differently. Shareholders are paid a salary, and the business pays their payroll taxes. These taxes can be deducted as a business expense, reducing the company’s taxable income. Any leftover profits are paid out as dividends to shareholders, which have a lower tax rate than salaried income.

Is an LLC or an S-Corp Better for Entrepreneurs?

There isn’t a right or wrong answer when it comes to deciding how your business will be taxed. For single-member businesses, it makes less sense to be an S-Corp since they would be required to pay themselves a salary. On the other hand, for multi-shareholder companies, it usually makes more financial sense to be an S-Corp, which can save a lot of money on taxes. This is especially true of shareholders who reside outside the U.S., who can then apply the Foreign Earned Income Exclusion, minimizing their income taxes.

As a business owner, you will want to figure out what is more important to you- the ultimate flexibility of an LLC, or the financial perks of an S-Corp. If you’re not sure which business structure is right for you, talk to a small business attorney.

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