When you are first starting your business, it is common to compare business structures. Figuring out the right one for you involves looking at how these structures are set up and determining what is the right fit for your specific business.
Let’s take a closer look. Both LLCs and S corps have similarities such as:
Limited liability protection.
For both LLCs and S corps, owners are typically not personally responsible for business debts and liabilities.
Both LLCs and S corps are separate legal entities created by a state filing.
Both LLCs and S corps typically pass-through tax entities. S corps must file a business tax return while LLCs only file business tax returns if the LLC has more than one owner. With pass-through taxation, no income taxes are paid at the business level. Business profit or loss is passed-through to the personal tax returns of the owner. Any necessary tax is reported and paid at the individual level only.
Ongoing state requirements.
Both LLCs and S corps have to meet state requirements such as filing annual reports and paying the necessary fees.
Now let’s take a look at the differences in ownership and formalities for LLCs and S corps.
The IRS restricts the extent of S corporation ownership, but not that of limited liability companies. These restrictions include limitations on number of members, where these members come from, ownership and subsidiaries.
While LLCs can have an unlimited number of members, S corps can have no more than 100 shareholders or owners. While non-U.S. citizens/residents can be members of LLCs, S corps may not have non-U.S. citizens/residents as shareholders. S corporations cannot be owned by C corporations, other S corporations, LLCs, partnerships or many trusts. However LLCs can be owned by other companies. Also LLCs are allowed to have subsidiaries without restriction.
S corporations have more extensive internal formalities which LLCs are recommended to have but do not have to legally.
Required formalities for S corporations include having bylaws, issuing stock, holding initial and annual director and shareholder meetings, and keeping meeting minutes with corporate records. For LLCs, recommended formalities include adopting an operating agreement, issuing membership shares, holding and documenting annual member meetings (and manager meetings, if the LLC is manager-managed), and documenting all major company decisions.
Differences in management.
Owners of an LLC can choose to have members (owners) or managers manage the LLC. If run by managers, the LLC more closely resembles a corporation where members will not be involved in the daily business decisions. S corps on the other hand have directors and officers. The board of directors oversees corporate affairs and handles major decisions but not daily operations. Instead, directors elect officers who manage daily business affairs.
Some additional differences include:
While an S corporation’s existence is perpetual, some states require LLCs to list a dissolution date in the formation documents. LLCs have to be renewed annually and can be dissolved when a member withdraws or dies.
Transferability of ownership.
While S corporation stock is freely transferable, as long as IRS ownership restrictions are met, LLC membership interest (ownership) typically can only be transferred to members.
S corporations may have self-employment taxes compared to the LLC because the owner can be treated as an employee and receive a reasonable salary after FICA taxes are withheld. Corporate earnings after salary is paid out, can also be treated as unearned income without any self-employment taxes. It is best to speak with your tax advisor regarding your specific business and eligibility for this.
Keeping these factors in consideration, you can decide which legal structure is right for your business.