When starting a business, you`ve many decisions; one is choosing a structure.
An LLC is a common choice because it offers many benefits to small business owners. The only problem is the more you earn, the more tax you`ll pay!
Another option is becoming an S corp; LLC owners often do this because of the tax savings.
An LLC and an S corp have important similarities, such as liability protection and pass-through taxation. But they also have significant differences that affect how much tax you`ll pay and how you pay it.
So, S corp vs. LLC, what is the difference?
Let’s find out so you can choose the best structure for your business.
An S corporation is a tax classification, not one of the many available business entities. And before you can become an S corp, you must first form an LLC or C corporation.
S corporations (and LLCs) are “pass-through entities,” and all profits pass through to the shareholder’s/owner`s tax return, avoiding corporation tax and double taxation.
LLC business owners whose income is higher than the industry average can elect S corp taxation to reduce their self-employment tax bill. You take a reasonable compensation (an average industry salary) and any remaining profits as distributions not subject to self-employment tax.
An LLC is a legal business structure that provides liability protection to its owners, protecting their assets in cases of debt or litigation.
There are 2 types of LLCS:
LLCs are popular because they’re easy to start and run, and you gain liability protection plus certain tax benefits. However, earning over $80,000 yearly could mean a hefty tax bill.
You can lighten your LLC tax load by applying for S corp taxation, which changes how you pay taxes on specific parts of your business income.
To start an LLC, you must file an article of organization with your secretary of state’s office. Then file Form 2553 to elect your tax classification with the IRS.
After approval and when your LLC meets specific IRS criteria, you can elect for S corp taxation.
Business entities cause much confusion among aspiring business owners, so let’s cut to the chase and look at the main differences between an S corp versus LLC:
There aren’t any IRS rules restricting LLC ownership, but there are with an S corporation; they include:
Management structure refers to who runs a business and how they implement high-level and daily decisions.
You can manage an LLC in 2 ways;
Manager-managed LLCs resemble an S corporation, as owners (members) do not participate in daily business decisions.
In contrast, S corporations have a board of directors that the shareholders (owners) elect. The directors handle critical decision-making and hire officers to run the business. Shareholders do not manage or take part in daily operations.
Single-member LLCs file and pay taxes like sole proprietors, and multi-member LLCs as partnerships. Both pay a 15.3% self-employment tax on all net profits.
To reduce their self-employment tax bill, single and multi-member LLCs can elect for S corp taxation if they meet IRS eligibility requirements.
S corp shareholders can work as employees and receive a salary (adequate compensation) for their service.
Wages are also subject to payroll taxes, at 15.3%, but the S corp pays 7.65% and employees the other 7.65%. Shareholders can then receive further payments as (distributions) which aren’t subject to payroll taxes.
LLC owners can split business profits and losses between members as they choose. For example, a multi-member LLC owner with a 50% interest could receive 70% of all profits and losses.
In contrast, S corp shareholders receive profits and losses relative to their percentage ownership.
LLCs cannot issue stocks, and there are no shareholders; instead, members receive payments relative to an LLC’s articles of organization.
An S corp can issue “common stocks” (shares of the business), giving shareholders voting right relative to their stock percentage ownership.
LLC business operations are more straightforward and have fewer requirements than other corporate structures.
Sure, the IRS and accountants advise LLCs to follow bylaws and corporate guidelines, such as conducting annual meetings and maintaining meeting minutes, but it’s not a legal requirement.
There are no restrictions regarding transferring the S corp stock to another person. Shareholders do not require their owners’ permission but may have tax matters to address on profits or losses and must adhere to the IRS ownership restrictions.
In contrast, LLC ownership (member’s interest) isn’t freely transferable, as owners need approval from all other members.
LLCs and S corporations are separate legal entities from their owners, who create them by filing with their state of business.
That said, LLCs and S corp formation requirements differ and are governed by different statutes (laws and rules) as per their location.
S corporations and LLCs are pass-through/flow-through tax entities. All profits and losses pass through to the members/shareholders, who report them on their tax returns, avoiding corporation tax and double taxation.
Choosing between an S Corp VS LLC is a significant decision for business owners.
You now know they have many similarities and essential differences. And if you form an LLC and don’t elect an S corp tax designation, you could miss out on substantial tax savings.
But if it were that straightforward, every entrepreneur would apply for S-corporation tax status.
As always, there are pros and cons you should consider and benefits to each structure that often influence your decision. Here are the essential pros and cons between S Corp Vs. LLC.
Many small business owners don’t begin with an S corp; instead, they transition organically as their business grows from a sole proprietorship/partnership to an LLC. And when their income warrants the tax savings, an S corp.
However, changing your business structure can incur tax penalties and involve extra fees. Choose one you can stick to before registering an entity.
But how do you know which structure is right for you? If that question sounds familiar, trust me, you’re not the first entrepreneur to ask it!
To choose a structure suitable for your business, evaluate your market’s opportunities and possibilities, whether you’ll need staff to take advantage of them, and the tax considerations each structure provides.
And remember, while complex business structures like S and C corporations allow for tax minimization, they also cost more to start and maintain.
There are 2 key reasons why you might choose an S corp over an LLC:
To start an S corp, you must first register a business entity, which is more expensive than running a business as a sole proprietorship. Let’s say you choose an LLC; once registered, you must file additional forms with the IRS and then consider taxes.
For example:
No. The LLC structure is more suitable for small business owners who manage daily operations and don’t earn more than the average industry wage.
Although an S corp and LLC provide complimentary benefits, the answer depends on your business needs and future aspirations.
Both provide limited liability protection and a pass-through tax structure avoiding double taxation.
LLC owners who require external funding to grow their business or whose income exceeds the industry average could reduce their self-employment tax bill and attract investors by electing S corp taxation.
Entrepreneurs who want to start an easier-to-run business but need liability protection should consider an LLC.
Possibly if your LLC`s profits exceed the industry average and you`d like to avail of any self-employment and payroll tax reductions.
Here`s how it works:
Yes, providing you meet the IRS requirements and file IRS Form 8832 to apply for your LLC to be taxed as a corporation and IRS Form 2253 to elect S Corporation status.
Your business can only have up to 100 shareholders. They must be eligible, meaning certain estates or trusts or individuals who are legal residents or US citizens.
Also, check the IRS website and review Form 2553 for eligibility and filing information.
To get S corp tax status, you must create a legal entity, like an LLC or C corporation, by registering with your state.
Upon approval from your secretary of state, apply for a federal tax number (EIN). Download, complete, and send Form 2553 to the Inland Revenue Service to request S corp delegation.
Forming an LLC structure is the next logical step for many general partnerships and sole proprietors. It formalizes their business and provides limited liability, protecting their assets from litigation and debt.
But there are cases when starting a business that an LLC isn`t the right choice; that`s when an S corp comes into play.
Your structure choice depends on your funding needs, business income, and future goals.
And as you need to form an LLC to get S corp designation, it`s a safe decision.
Hi, I`m a business and marketing writer living the digital nomad lifestyle between Spain and Italy for over three years now.
This portion of our website is for informational purposes only. Tailor Brands is not a law firm, and none of the information on this website constitutes or is intended to convey legal advice. All statements, opinions, recommendations, and conclusions are solely the expression of the author and provided on an as-is basis. Accordingly, Tailor Brands is not responsible for the information and/or its accuracy or completeness. It also does not indicate any affiliation between Tailor Brands and any other brands, services or logos.
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