When starting a business, many new business owners (and some existing business owners) debate the question of whether to start an LLC vs. S Corporation. Which choice of entity is better for your business? The answer depends on a few variables that are specific to your company. But if you evaluate your options carefully, you can choose a business structure to maximize your tax benefits and legal liability protections.
LLC and S Corp Similarities
LLCs and S Corps have a few key things in common. They are both legal business structures that make your business “official” as a separate legal entity from your personal identity and finances. Whether you decide to form an LLC or set up an S Corporation, both options give you personal liability protection in case of a lawsuit and let you build credit under the name of your business by setting up business bank accounts and lines of credit.
Another similarity is that both the LLC and S Corporation are “pass-through” entities that do not pay corporate income taxes; instead, the company’s income “passes through” to the company owners and is reported on their personal tax returns. This feature helps you avoid the double taxation of a C Corporation.
LLC vs. S Corp: Differences
There are a few big differences in the LLC vs. S Corp distinction as well. In general, an LLC offers a more flexible business structure that lets you manage the ownership of your business in a more expansive way (no ownership restrictions, for example). This means that if you have business partners who are foreign nationals, they can share ownership in your LLC. Or a solo business owner can form a single-member LLC that gives you bigger protections and more possible tax advantages than you could receive doing business under your own name as a sole proprietor.
The LLC also allows you some flexible options in terms of business structure. Depending on your state, you can set up a Series LLC that owns several other LLCs as a kind of “umbrella organization.” Or you can have an LLC that is owned by another corporation or LLC. Depending on the needs of your business and the wishes of any business partners or shareholders you might have, the LLC can be a versatile option to structure your company.
In contrast, an S Corporation is more limited and less flexible in its ownership structure. An S Corp can only have 100 shareholders, and all of them must be U.S. citizens or legal residents. The S Corporation is also only allowed to issue one class of stock, making it a less versatile way to structure the ownership of your business.
Another limitation of the S Corporation (compared to the C Corporation) shares of an S Corp cannot be publicly traded. So if you want to someday have an IPO on Wall Street, you would want to go with a C Corporation instead of an S Corp.
From a tax perspective, one big advantage of an S Corporation instead of an LLC is that the tax treatment of S Corporation income is more flexible. With a typical LLC, the company’s income just passes through directly to the owners’ personal income tax returns, where it’s taxed like ordinary self-employment income (including a double share of employment taxes). With an S Corporation, the owners have the flexibility to pay themselves a salary that is a small percentage of the company’s total income, and then classify the remaining income as a “distribution” from the company, which is not subject to employment tax. This can help reduce your overall tax burden while maximizing your flexibility for how to save, spend and invest your business income.
Advantages of an LLC Filing as an S Corp
Now that you understand the differences between an LLC vs. an S Corp…what if there was a way to get the best of both worlds? What if you didn’t have to choose between the two?
If your business ownership setup allows for it — for example, if you are a single-member LLC owner with no other partners or shareholders — you can have your LLC file taxes as an S Corporation. This gives you the flexibility and minimal compliance obligations of running an LLC, while still letting you qualify for the favorable tax treatment of S Corporation income.
Be careful when managing your tax reporting and compliance responsibilities; an LLC filing as an S Corporation requires careful treatment and professional advice from an accountant or tax attorney. You will need to file IRS Form 2553 and deal with a few other extra complexities of handling your business taxes in this way.
Want to see how filing taxes as an S Corporation could help you save money at tax time? Check out Incfile’s S Corp Tax Calculator.
The LLC vs. S Corp debate doesn’t have to end with one “right” answer. Depending on your business needs and the level of complexity that you require from your business entity and ownership structure, you might find that you can get the best of both worlds — the flexibility of an LLC and the advantageous tax treatment of an S Corp.
Are you ready to start a business, form an LLC or S Corporation, or reorganize your current business structure with business incorporation services? Talk to Incfile today! Our incorporation experts can help you evaluate your options with state-specific advice.