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As you start to research entity types for your dream business, you’ll probably hear options like “LLC” and “S corp” and wonder which is the better choice.

What is the difference between an S Corp and an LLC?

That’s because these terms aren’t mutually exclusive. In fact, they’re different things completely. Limited liability companies (LLCs) are a type of business entity. It’s a separate legal entity, just as a corporation is. An S corporation (S corp) is not a business entity type, but a tax classification, one that could save some LLC owners a lot of money in self-employment taxes. LLCs and corporations both have the option to be S corps, provided they meet the criteria.

Let’s first dive into what each of these terms means.

What is an LLC?

As explained above, an LLC is a legal business entity intended to provide limited liability protection to the owners (who are called members in an LLC). Creating a separate legal entity with an LLC or corporation usually protects the personal assets of the owners from those making a claim against the company.

In other words, if someone sues the business or the business goes into debt, they’re usually limited to making claims against the company’s assets, and the personal assets of the owners (for example, their personal bank account, house, kid’s college fund, etc.) are off-limits.

It used to be that the only way for a business owner to get this kind of liability protection was to form a corporation, but this wasn’t ideal for everyone.

LLCs and Taxation

For starters, corporations have to deal with “double taxation.” Basically, when the corporation makes a profit, the corporation itself is taxed on the profits. Then, when the profits are distributed to the individual owners (“shareholders”), the profits are taxed again. 

LLC members, though, can avoid this double taxation by being taxed as a sole proprietorship or general partnership. In that case, the LLC itself isn’t taxed on profits. The profits are only taxed once, when they’re distributed to the individual members, who pay those taxes on their individual tax returns. This is known as “pass-through” taxation.

LLC members also have the option to be taxed as a corporation, which we’ll get into later when we talk about S corps.

The other major benefit provided by the LLC business entity is formality, or rather the lack thereof. By law, corporations must appoint a board of directors, hold annual shareholder meetings, keep extensive records, and generally adhere to more regulations. They’re also limited in how they can be organized and managed. LLCs have much more freedom.

As long as all the members agree, they can manage the LLC how they want, which includes dividing up ownership and profits in the way they prefer. They just have to put it all in writing in an operating agreement

What is an S Corp?

As we mentioned, an S corp is a tax classification, one that both LLCs and C corporations (the most common form of corporation) can apply for. The “S” refers to Subchapter S of the Internal Revenue Code.

The S corporation tax classification can have advantages for both corporations and LLCs. For corporations, it’s usually a way for them to avoid double taxation because it allows them to be taxed like a pass-through entity. LLCs already have pass-through taxation by default, but they can usually save the members a lot of money in self-employment taxes by filing as an S corp. More on that later.

S Corp Filing Requirements

Not every corporation or LLC can qualify for S corporation status, though. They must meet the following requirements, which include having:

  • Only U.S. shareholders (or members for an LLC), which can be individuals, certain trusts, and estates
  • No shareholders/members that are partnerships, corporations, or non-resident aliens
  • No more than 100 shareholders/members
  • Only one class of stock

An LLC or corporation needs to complete Form 2553 with the IRS to apply for S corp status.

What are the benefits of an LLC?

So, what are the advantages and disadvantages of LLC vs. S corp?

S corps and LLCs that haven’t elected S corp status share the benefit of pass-through taxation. But non-S corp LLCs have the benefit of not having to adhere to the regulations for S corps we listed above.

An LLC that doesn’t apply for S corp status can actually avoid filing two forms with the IRS. To become an S corp, an LLC must first file Form 8832 to be taxed as a C corporation before filing Form 2553 to be taxed as an S corporation.

LLCs without S corp status will also have less-complicated taxes. An S corp LLC will have the added step of filing Form 1120S, U.S. Income Tax Return for an S Corporation, at tax time. And, generally speaking, the S corp status invites more scrutiny (read: audits) from the IRS than a standard LLC.

Because of this additional scrutiny, S corps may want to do many of the same formalities that C corporations have (such as regular meetings and extensive record keeping) even if they’re not legally required to. It can come in handy in an audit.

What are the benefits of an S Corp?

For an LLC, S corp status could mean saving a lot of money in taxes. Here’s how:

A standard LLC can’t employ its own members; the LLC members are considered self-employed. This means that they’ll pay self-employment taxes (about 15.3%) on all profits they receive from the LLC. This is more than the taxes they’d pay when working for someone else because their employer would pay part of them.

By electing S corp status, though, members can become employees of the LLC and receive a salary. Once they do that, they only pay self-employment taxes on that salary and not the remaining profits. This can add up to thousands of dollars.

However (remember the scrutiny we mentioned earlier?), the IRS expects you to pay yourself at least a “reasonable” salary (as in, something on par with what others in your field are making) so that you’ll still pay something in self-employment taxes and contribute to Social Security and Medicare. So, if you’re thinking of paying yourself an annual salary of $2 to avoid taxes, think again.

Are S corp earnings subject to self-employment tax?

Owners of an S corp are not considered self-employed, so they can pay themselves a salary from the company. They’ll pay self-employment taxes on that salary, but not the remaining profits. This can mean substantial savings and is one of the benefits for an LLC filing as an S corp.

When should your company become an S corp?

That will depend on your business’s circumstances (again, a tax professional can help here). As far as the time of year to file, if you’re a new business, you must file Form 2553 no more than 2 months and 15 days after the beginning of the tax year the S corp election is to take effect. If you have an established business, you could file at any time during the tax year preceding the tax year it is to take effect. The IRS has more details on the instructions for Form 2553.

Is an S corp an LLC?

An S corp is a tax classification, while an LLC is a legal business entity. LLCs and corporations can both apply to be S corps.

What is pass-through taxation?

Pass-through taxation occurs with business entities like sole proprietorships, partnerships, and LLCs, where the profits for the business are only taxed once, when they’re distributed to the individual members. This is as opposed to double taxation, in which the business itself is taxed on the profits before they’re distributed to the individuals owners, where they’re taxed a second time.

Can a single-member LLC be an S corp?

Yes. Only having one owner of the LLC doesn’t disqualify it from filing to be an S corp.

How can we help?

Now that you understand the basics of the benefits of an S corp vs. an LLC (without an S corp status), you’ll have to weigh all the factors to see which choice best fits you and your business. We don’t recommend doing this alone, though. It’s times like these when you need a skilled tax professional to help you make a decision.

If you’re planning to start an LLC, with or without the S corp designation, we can handle the process for you. Our LLC formation service sets you up with experts who can file the paperwork with the state for you. And, if you’d like to form your LLC as an S corp, our S corporation service can take care of that added step, too. Once you’re established, we have other services like Worry-Free Compliance to help you stay compliant with government regulations.

You can do this. We can help.

Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.

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