Understanding the Difference Between an LLC and an S Corp

You have many options when it comes to choosing a structure for your business. Two of the most popular options include the limited liability company (LLC) and the S Corporation (S Corp). These two business entities have many similarities although it’s important to understand the differences and how they will affect your taxes, business management, and more.

What are the Benefits?

Whether you choose to form an LLC or an S Corp, you will benefit from limited liability protection, which means your personal assets like your home and retirement savings are protected from business creditors. You can only be held responsible for the amount you have invested in your company.

Related Article: S Corporation: What Are the Benefits?

Both options can also save you on personal and corporate taxes by deducting pre-tax business expenses. The big difference is S Corp owners are required to pay themselves a fair salary plus dividends from profits the company earns. An LLC, on the other hand, is a pass-through entity. This means all business losses, profits and expenses are reported on the owners’ personal income tax returns.

What are the Differences?

Both an LLC and an S-Corp offer unique advantages and disadvantages.

Forming an LLC comes with several benefits. If your form a single member LLC, you do not need to file a tax return for the company as all activity is reported on your own tax return. LLCs are also incredibly easy to form and very inexpensive. In most states, it costs just a couple hundred dollars. There are also few stringent requirements to meet, unlike an S corp.

On the downside, a single member LLC owner must pay self-employment taxes on any income the company generates and pay quarterly estimated IRS payments.

The main advantage to choosing an S Corp instead of an LLC is the tax benefits for excess profits or distributions. An S Corp must pay employees (and owners) a reasonable salary tied to the industry norm. Any remaining profit can be distributed to owners as dividends with a much lower tax rate.

There are some disadvantages. There are strict guidelines that must be met to form an S Corp. Owners must be U.S. citizens or residents. There can be no more than 100 shareholders of the company and only one class of stock can be issued. All profits and losses must be distributed to shareholders based on the shareholders’ interest in the company as well so disproportionate distributions is not allowed, unlike an LLC.

S Corps also have much stricter ongoing requirements to meet and forming this type of business entity is always more expensive.

Which is Best for You?

Not sure which option will work best for your business? If you prefer a structure that’s cheaper to set up and maintain and you want less red tape, an LLC may be the best choice. With an LLC, you can always choose to be taxed as an S Corp while enjoying the same looser structure of an LLC. You may choose to be taxed as an S Corporation as your business becomes more successful and your income grows.

If you have a fast-growing business and you plan to turn to investors or share ownership, it may be better to start off with an S Corporation right off the bat.

There is no right answer for every business. It’s important to consider all of the ramifications of your decision before your incorporate or form an LLC and discuss your options with an attorney or business services company. Click here to learn more about the types of business structures available and which may be best for your business.

Author: USA Corporate Services, Inc. is a company dedicated to helping entrepreneurs protect themselves by establishing a formal business structure for their startup. USA Corporate offers company formation services as well as registered agent services, mail forwarding, and business startup resources. Follow them on Facebook, Twitter, and LinkedIn.