7 Differences Between LLC and S Corp You Need to Know
If you are starting a business, you may be wondering what is the best legal structure for your company. Should you form a limited liability company (LLC) or a corporation (S corp)? What are the advantages and disadvantages of each option? How do they affect your taxes, liability, and management?
In this article, we will explain the main differences between LLC and S corp, and help you decide which one is right for your business. We will cover the following topics:
– What is an LLC and what is an S corp?
– How are they taxed?
– How do they protect your personal assets?
– How do they affect your control and flexibility?
– How do they impact your credibility and image?
– How do you form an LLC or an S corp?
– How do you choose between an LLC and an S corp?
What is an LLC and what is an S corp?
An LLC is a type of business entity that combines the features of a partnership and a corporation. It allows you to have the flexibility and simplicity of a partnership, while enjoying the limited liability protection of a corporation.
An S corp is a special type of corporation that elects to be taxed as a pass-through entity. This means that the income and losses of the corporation are passed through to the shareholders, who report them on their personal tax returns.
How are they taxed?
One of the main differences between LLC and S corp is how they are taxed. An LLC can choose to be taxed as a sole proprietorship, a partnership, a C corporation, or an S corporation. This gives you the flexibility to choose the most favorable tax treatment for your situation.
An S corp can only be taxed as an S corporation. This means that it avoids double taxation, which occurs when a corporation pays taxes on its income, and then the shareholders pay taxes again on their dividends. Instead, an S corp pays no corporate income tax, and only the shareholders pay taxes on their share of the income.
However, both LLCs and S corps have to pay self-employment taxes on their profits. Self-employment taxes are composed of Social Security and Medicare taxes, which are normally paid by both employers and employees. As an owner of an LLC or an S corp, you are considered both an employer and an employee, so you have to pay both portions of these taxes.
One way to reduce your self-employment taxes is to pay yourself a reasonable salary as an employee of your business, and then distribute the remaining profits as dividends. Dividends are not subject to self-employment taxes, but only to income taxes. However, this option is only available for S corps, not for LLCs.
How do they protect your personal assets?
Another important difference between LLC and S corp is how they protect your personal assets from the liabilities of your business. Both LLCs and S corps offer limited liability protection, which means that your personal assets are generally not at risk if your business is sued or goes bankrupt.
However, there are some exceptions to this rule. For example, if you personally guarantee a loan for your business, or if you commit fraud or negligence in your business activities, you may still be held personally liable. Also, if you fail to follow the proper formalities of running your business, such as keeping separate bank accounts, records, and documents for your business and personal affairs, you may lose your limited liability protection. This is called piercing the corporate veil.
How do they affect your control and flexibility?
Another difference between LLC and S corp is how they affect your control and flexibility over your business. An LLC gives you more freedom and flexibility to run your business as you wish. You can decide how to allocate profits and losses among the members (owners) of the LLC, how to manage the day-to-day operations of the business, and how to make important decisions for the future of the business.
An S corp gives you less freedom and flexibility to run your business as you wish. You have to follow certain rules and regulations imposed by the IRS and the state law. For example, you have to distribute profits and losses among the shareholders (owners) of the S corp in proportion to their ownership interest, you have to elect a board of directors and officers to manage the business affairs, and you have to hold regular meetings and keep minutes of those meetings.
How do they impact your credibility and image?
Another difference between LLC and S corp is how they impact your credibility and image in the eyes of potential customers, investors, partners, suppliers, and lenders. An S corp may have more credibility and image than an LLC because it is more established and regulated than an LLC. An S corp may also have more access to capital than an LLC because it can issue stock to raise funds from investors.
An LLC may have less credibility and image than an S corp because it is newer and less regulated than an S corp. An LLC may also have less access to capital than an S corp because it cannot issue stock to raise funds from investors.
How do you form an LLC or an S corp?
Another difference between LLC and S corp is how you form them. To form an LLC, you have to file a document called Articles of Organization with the state where you want to operate your business. You also have to create an operating agreement, which is a contract that outlines the rights and responsibilities of the members of the LLC.
To form an S corp, you have to file a document called Articles of Incorporation with the state where you want to operate your business. You also have to create bylaws, which are rules that govern the internal affairs of the corporation. In addition, you have to file a form called Form 2553 with the IRS to elect S corporation status.
How do you choose between an LLC and an S corp?
The choice between an LLC and an S corp depends on several factors, such as:
– Your tax situation
– Your liability exposure
– Your management style
– Your growth plans
– Your personal preferences
There is no one-size-fits-all answer to this question. You should consult with a qualified attorney and accountant to help you weigh the pros and cons of each option and decide which one is best for your specific situation.
The Rise of LLCs and S-Corps
One of the most important decisions for a business owner is choosing the right legal structure and tax classification for their company. In recent years, more and more businesses have opted for limited liability companies (LLCs) and S corporations (S-corps) as their preferred business entities. According to the IRS, the number of LLCs increased by 27% from 2015 to 2019, while the number of S-corps increased by 8% in the same period. These two business structures offer some key advantages for small and medium businesses, such as liability protection, pass-through taxation, and flexibility in management and profit-sharing.
LLC vs. S-Corp: What’s the Difference?
Although LLCs and S-corps are often talked about together, they are not an either-or choice. An LLC is a legal business structure that protects the owner’s personal assets from the company’s debts. An S-corp is a tax classification that’s available to some small businesses that meet certain criteria. Both LLCs and corporations can elect S-corp taxation by filing a form with the IRS. The main difference between an LLC and an S-corp is how they are taxed. An LLC can choose to be taxed as a sole proprietorship, a partnership, a C corporation, or an S corporation, depending on its situation and preferences. An S-corp is always taxed as a pass-through entity, meaning that the business income or losses are reported and taxed on the owner’s personal tax return. This can help avoid double taxation that occurs when a C corporation pays corporate taxes and then distributes dividends to shareholders who pay personal taxes on them.
References:
https://www.irs.gov/pub/irs-pdf/f2553.pdf
https://www.irs.gov/pub/irs-pdf/i2553.pdf
https://www.govinfo.gov/content/pkg/USCODE-2009-title26/pdf/USCODE-2009-title26-subtitleA-chap1-subchapS.pdf
https://www.investopedia.com/articles/personal-finance/011216/s-corp-vs-llc-which-should-i-choose.asp
https://www.forbes.com/advisor/business/llc-vs-s-corp/
https://www.irs.gov/businesses/small-businesses-self-employed/limited-liability-company-llc
https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations
https://www.sba.gov/business-guide/launch-your-business/choose-business-structure
https://www.nolo.com/legal-encyclopedia/llc-basics-30163.html
https://www.nolo.com/legal-encyclopedia/s-corporations-basics-30140.html
