Differences between LLC and S Corporation
Contents
Comparison Article
Individual business owners in the United States often choose between the limited liability company (LLC) and the S corporation (S corp) to protect personal assets and manage tax liabilities. While both structures offer limited liability protection, they differ in legal nature, ownership eligibility, and tax treatment.
An LLC is a business entity created by state statute. It is a legal structure that protects owners—referred to as members—from personal liability for the debts or court judgments of the business.[1] An S corporation is not a legal entity itself; rather, it is a tax designation for a corporation or LLC that meets specific Internal Revenue Code requirements. To become an S corp, a business must first form as a corporation or LLC and then file Form 2553 with the IRS.[2]
Comparison of LLC and S corporation
| Category | LLC | S corporation |
|---|---|---|
| Entity type | Legal business structure | Tax designation |
| Ownership limits | Unlimited number of members | Maximum 100 shareholders |
| Ownership eligibility | Open to individuals, corps, and non-residents | U.S. citizens or residents only |
| Management | Flexible (Member-managed or Manager-managed) | Mandatory Board of Directors and Officers |
| Taxation | Pass-through (default) | Pass-through (S-election) |
| Self-employment tax | Typically paid on all net profit | Paid on salary only; distributions exempt |
| Administrative burden | Low (Operating agreement recommended) | High (Required meetings and minutes) |
| Stock classes | Multiple classes allowed | Single class of stock only |
Taxation and self-employment costs
The primary difference between these structures involves how owners pay self-employment taxes. In a standard multi-member LLC, the IRS treats the entity as a partnership for tax purposes. Each member pays self-employment tax (Social Security and Medicare) on their entire share of the business profits.[3]
An S corporation allows owners who work for the business to split their income into a "reasonable salary" and profit distributions. The salary is subject to FICA payroll taxes, but the remaining distributions are not subject to self-employment tax. This can lead to tax savings if the business generates significant profit beyond the owner's salary.[4]
Formalities and management
LLCs have fewer administrative requirements. Most states do not require LLCs to hold annual meetings or keep formal minutes, though an operating agreement is used to define management roles. Corporations electing S corp status must adhere to stricter corporate formalities. This includes adopting bylaws, issuing stock certificates, holding initial and annual meetings, and recording meeting minutes to maintain their legal standing.[3]
Ownership restrictions
LLCs offer more flexibility regarding who can own the business. Corporations, partnerships, and non-U.S. residents can be members of an LLC. S corporations are restricted to U.S. citizens and permanent residents. Furthermore, S corporations cannot be owned by other C corporations, LLCs, or partnerships. They are also restricted to a single class of stock, which means all shares must provide identical rights to distribution and liquidation proceeds.
References
- ↑ Internal Revenue Service. "Limited Liability Company (LLC)." IRS.gov. Accessed May 15, 2024.
- ↑ U.S. Small Business Administration. "Choose a business structure." SBA.gov. Accessed May 15, 2024.
- ↑ 3.0 3.1 Internal Revenue Service. "S Corporations." IRS.gov. Accessed May 15, 2024.
- ↑ Cornell Law School. "26 U.S. Code Subchapter S - Tax Treatment of S Corporations and Their Shareholders." Legal Information Institute. Accessed May 15, 2024.
