Choosing whether to run your business as an LLC or elect S-corp status for taxation is an important decision that can affect your business’s tax, growth potential, and compliance obligations.
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Many new business owners experience difficulty deciding between an S corp and LLC for their business. This is understandable since business and tax laws are complicated and constantly change.
However, not understanding the key differences between LLCs and S corps could lead you to make the wrong decision for your business, limiting its growth and increasing its tax burden.
To help you out, this article closely examines LLCs vs S corps, highlighting their common features and where they differ.
Using this article as a starting point, you can begin to determine which option might be better for you. From there, you can consult with legal and tax advisors.
Key Takeaways
- An LLC is a business structure in which the business is a separate legal entity from its owners. They can have unlimited owners.
- An S corp is a corporation that has elected to be taxed as a pass-through entity, avoiding double taxation. It’s limited to 100 shareholders.
- Choosing which is best for your business depends on various factors, including the business’s size, goals, and tax situation. You should consult legal and tax experts who can explain each option in detail and guide your decision-making.
- Whether you run an S corp or LLC, consider using Connecteam to communicate with and manage your deskless workforce seamlessly.
What Is an S Corp?
An S corporation (S corp) isn’t a business structure but rather a tax status available to smaller businesses. The “S” refers to the subchapter in the Internal Revenue Rules (federal tax rules) that outlines how S corps are taxed at the federal level.
Businesses with S-corp status operate as “pass-through entities” for tax purposes. As a pass-through entity, S corps don’t pay federal corporate income taxes.
Instead, business profits and losses “pass through” to the owners (shareholders), who report them in their individual tax returns to be taxed at their personal rate.
A business must meet specific requirements to be taxed as an S corp, including:
- Its owners must incorporate (form) it in the US.
- Its owners (shareholders) can be individuals, certain trusts (entities managing assets for beneficiaries), and estates (assets left after death).
- It can’t have more than 100 shareholders.
Some corporations, such as insurance companies and certain financial institutions, can’t elect S-corp status.
What Is an LCC?
A limited liability company (LLC) is a legal business structure for US businesses. It creates a legal entity that’s separate from its owners (members), protecting them from personal liability for the business’s debts.
There are no restrictions on who can own LLCs. They can have 1 or many owners, including foreign investors, corporations, and other LLCs.
Small businesses often prefer LLCs because they balance the simplicity of sole proprietorships and partnerships with the limited liability (protection of personal assets) corporations offer.
🧠 Did You Know?
Sole proprietorships are businesses owned by 1 individual, with no legal distinction between the owner and the business. Partnerships involve 2 or more individuals jointly owning and operating a business.
The laws around how LLCs are formed and run vary between states.
📚 This Might Interest You:
Thinking of setting up your own small business? Check out our step-by-step guide to doing so, including how to choose the right business structure.
Similarities and Differences Between LLCs and S Corps
S Corp vs. LLC: Key Differences
| Feature | S Corp | |
|---|---|---|
| Taxation: | Pass-through taxation: Profits and losses flow through to owner’s personal tax returns | Pass-through taxation: Profits and losses flow through to owner’s personal tax returns |
| Formation: | More complex, requires filing Articles of Incorporation, election with the IRS | Simpler, requires filing Articles of Organization |
| Management: | Board of directors and officers required | Flexible management structure, not required |
| Formal Requirements: | Stricter record-keeping and reporting requirements | Less stringent record-keeping and reporting requirements |
| Ownership Restrictions: | Maximum of 100 shareholders, all must be U.S. citizens or permanent residents | No ownership limitations |
| Employee Benefits: | Can offer qualified retirement plans and other employee benefits | May face limitations on offering certain benefits |
| Suitability for: | Established businesses seeking to avoid double taxation, businesses with active owners who want to maximize salary deductions | New businesses, solopreneurs, businesses with simple ownership structure |
Limited liability
LLCs and S corps have their own legal identities. The law treats these businesses as people—they can enter into contracts, sue other parties, and be sued. As a result, owners aren’t personally responsible for the debts and liabilities (other financial obligations) of their LLC or S corp. So, their personal assets are protected from business creditors.
This limited liability often attracts business owners. Other business structures, like sole proprietorships and partnerships, don’t offer limited liability—which means their owners are personally responsible for the businesses’ debts and liabilities.
Taxation
Pass through entities
LLCs and S corps are both pass-through entities for federal tax purposes.
Business income, losses, deductions, and credits pass to the owners.
As pass-through entities, LLCs and S corps avoid the “double taxation” some other types of business face. For example, C corps’ business income is taxed at a corporate level, and owners also pay taxes on business profits.
LLCs are taxed based on their ownership structure. Single-owner LLCs are taxed like sole proprietorships, while LLCs with multiple owners are taxed like partnerships. (Sole proprietorships and partnerships are also pass-through entities.)
Some state laws impose a corporate income tax on S corps (your tax advisor can tell you more about these).
LLCs can also elect to be taxed as C corps or S corps. Business owners typically do this to lower their overall tax burden. To elect S-corp status, LLCs must meet the eligibility criteria for S corps and file Form 2553—“Election by a small business corporation”—with the IRS.
Self-employment taxes
Some business owners opt for S corps over LLCs to reduce self-employment taxes.
LLC members working in the business are treated as self-employed, and all business earnings are subject to self-employment taxes.
In contrast, S corp owners who are also employees aren’t considered self-employed since they receive salaries and distributions (profits paid out to shareholders from the company’s earnings). Salaries are subject to payroll taxes (Social Security and Medicare taxes)—not self-employment taxes. Any other distributions employees receive aren’t subject to payroll or self-employment taxes.
🧠 Did You Know?
Under the Federal Insurance Contributions Act (FICA), everyone who works must pay Medicare and Social Security taxes. When you’re employed, you pay half these taxes and your employer pays the other half. Self-employed workers must pay the full amount themselves.
The IRS closely monitors S corps to ensure employee salaries are reasonable and not artificially low as a tactic to minimize payroll taxes.
Continued existence
S corps continue to exist if an owner passes away.
In comparison, single-owner LLCs typically end when their owner dies. For LLCs with multiple members, the operating agreement usually addresses what occurs when a member dies.
🧠 Did You Know?
An operating agreement is a legal contract between an LLC’s owners. It sets out how to manage and run the LLC.
Ownership
There are strict rules around ownership for S corps but not LLCs.
S corps are owned by shareholders: those who own “stock” in the corporation (shares of its ownership). Under the Internal Revenue Code, S corps’ shareholders can’t be partnerships, corporations, or non-resident non-citizens. Plus, S corps can’t have over 100 shareholders.
In comparison, LLCs can have unlimited members. These members can be foreigners, partnerships, or corporations.
S corps can only issue 1 class (type) of stock. Different classes of stock give shareholders certain rights, such as receiving dividends (a portion of the business’s profits) and voting on important decisions like electing board members. An S corp can’t issue stock that gives different financial rights to different shareholders.
LLCs don’t issue stock. Instead, LLC members hold a membership interest in the company and share in its profits.
An LLC’s inability to issue stock limits its capital-raising options, as it can’t offer ownership shares to public or private investors—a typical way for businesses to get significant funding. This restriction means LLCs might struggle to obtain the large financial investments that S corps can secure by selling shares.
Management structure
The management structure of LLCs and S corps also differ.
S corps have a rigid management structure. Shareholders appoint a board of directors to oversee management decisions and company compliance. The directors appoint officers, such as a chief executive officer (CEO), to handle the company’s day-to-day running.
In contrast, LLC members can choose to manage the business themselves or appoint managers. LLCs managed by multiple members are run like partnerships, while single-member LLCs operate like sole proprietorships. When they appoint managers, members aren’t involved in the business’s daily operations.
Profit sharing
Profit sharing in S corps is more rigid than in LLCs.
S corp profits and losses are divided between shareholders based on their ownership percentage. Shareholders may hold 1 or more shares in a corporation. Their number of shares represents their ownership percentage and allocation of profits. For example, a shareholder who owns 30% of the company receives 30% of its profits.
LLCs have more flexibility to allocate profits and losses, and members can decide how to split them. Agreed profit-sharing arrangements are typically set out in an LLC’s operating agreement.
Transfer of ownership
S-corp shareholders can freely transfer their shares to other owners if they meet shareholder eligibility requirements.
It can be more difficult to transfer ownership in an LLC, as it may require the consent of other members. An LLC’s operating agreement usually includes rules and processes for transferring membership.
Establishment documents
Forming an LLC or S corp involves filing different documents.
To create an S corp, you must first file articles of incorporation with the relevant state agency—for example, the Secretary of State’s office—and pay the associated filing fee. Articles of incorporation set out key details about a company, including its contact information and the board of directors.
Filing articles of incorporation creates a C corp, the standard form of company. You then file a Form 2553 with the IRS to elect to be taxed as an S corp.
Members file articles of organization to form an LLC with the relevant state agency. Articles of organization are the equivalent of articles of incorporation. Some states call articles of organization by a different name, such as “certificate of formation.”
💡 Pro Tip:
The Small Business Administration offers a guide to registering your business, which includes a tool to find your relevant state agency.
Compliance
LLCs and S corps have compliance obligations. Both must file annual reports containing up-to-date contact information for the business and engage a registered agent. (A registered agent is a person or business appointed to receive legal documents for another business in the state of its formation.)
However, the other requirements for S corps are more demanding, with some business owners preferring the flexibility LLCs offer. S corps must:
- Conduct annual shareholder meetings to elect a board of directors and vote on other issues.
- Create and keep minutes (records) of these meetings for transparency and audit purposes.
- Adopt bylaws. Bylaws are internal rules that govern a corporation’s management and decision-making processes. They typically outline the business’s corporate structure, detail the process of shareholder meetings, and set out directors’ powers and responsibilities.
This strict oversight can cost S corps more time and money, but it can also enhance an S corp’s credibility.
While these requirements aren’t mandatory for LLCs, best practices suggest LLCs should also follow them to ensure transparency. For example, LLCs can conduct annual manager and member meetings and adopt an operating agreement.
🧠 Did You Know?
Connecteam is a great way to manage compliance, whether you run an LLC or S corp. You can use Connecteam to create digital forms and centrally store business documents—including meeting minutes, bylaws, and operating agreements—in a secure location.
Which Is Better for Your Business: LLC vs S corp
Whether an S corp or LLC is better for your business depends on various factors, including your needs, financial circumstances, and goals.
For example, you may choose an LLC when:
- You want limited liability but prefer to avoid strict corporate formalities.
- The business has over 100 owners.
- You run a single-owner business.
Alternatively, you may choose an S corp when:
- You aim to lower self-employment taxes.
- The business has fewer than 100 owners.
- You have multiple owners and want the oversight of a board of directors.
- You run a larger company.
One of the main reasons business owners choose an LLC over an S corp or vice versa is the tax benefits they offer. Speak with a tax advisor to understand which one better suits your needs.
How Connecteam Can Support Your LLC or S Corp
When evaluating LLCs vs. S corps for your business, you must understand their shared features and critical differences. Both provide limited liability and pass-through taxation. However, S corps involve more ownership restrictions and formal governance, while LLCs can’t issue stock. The right choice for your business depends on your business’s circumstances, and you must speak to a tax and legal advisor for tailored advice when making your decision.
After creating your S corp or LLC and hiring employees, the next step is finding a tool to help you manage your workforce. Connecteam’s app is an ideal solution, offering streamlined communication, collaboration, and operations management features. With its user-friendly interface, Connecteam simplifies onboarding, training, time tracking, scheduling, and more. Connecteam contributes to your business’s success by supporting an efficient and motivated workforce.
FAQs
Can an S corp own an LLC?
An S corp can own a single-member or multi-member LLC. An S corp that owns an LLC often does so as a holding company. This separates the S corp’s assets from the LLC’s assets.
When should an LLC become an S corp?
Many business owners choose to change from an LLC to an S corp when their self-employment taxes become higher than the taxes they’d pay as an S corp. The specific point where this becomes the case varies depending on the business’s circumstances.
Disclaimer
The information on this website about S corps vs LLCs in the United States is intended to be a summary for informational purposes only. However, laws and regulations regularly change and may vary depending on individual circumstances. While we have made every effort to ensure the information provided is up to date and reliable, we cannot guarantee its completeness, accuracy, or applicability to your specific situation. Therefore, we strongly recommend that readers seek guidance from their legal department or a qualified attorney to ensure compliance with applicable laws and regulations. Please note that we cannot be held liable for any actions taken or not taken based on the information presented on this website.