S Corp vs LLC: Which is Right for Your Business?

An S-Corp and an LLC both offer limited liability protection, meaning the owners are not personally responsible for business debts and liabilities. They also both allow for pass-through taxation, where the profits or losses of the business pass through to the owners’ personal tax return and are taxed at individual tax rates.

However, there are some key differences between the two that can benefit different types of businesses. An S-Corp is often more attractive to small-business owners who can qualify for significant tax savings once the business’s income reaches a certain level. S-Corps can also provide additional benefits like salary and dividends, which could lead to lower Social Security and Medicare taxes.

On the other hand, an LLC provides more flexibility regarding management structure and profit distribution. It is easier to form and maintain, making it a popular choice for startups and small businesses. Additionally, an LLC can have any number of members, while an S-Corp is limited to 100 shareholders, and all shareholders must be U.S. citizens or residents.

Let’s Compare the Two Corporate Structures

As previously mentioned, Limited liability companies (LLCs) and S corporations share many characteristics. Key similarities include limited liability protection, recognition as separate entities, pass-through taxation, and similar state requirements.

Limited liability protection shields business owners from personal responsibility for the business’s debts and potential liabilities. This means that the business owners are either not accountable or only partially accountable for these debts and liabilities.

Both LLCs and S corporations are considered separate entities by the state once they’ve been officially registered.

These businesses are also pass-through tax entities, meaning they are exempt from income tax. Instead, the business owners are taxed directly based on the company’s revenues and losses. While S corporations are required to file tax returns annually, an LLC only needs to do so if it has more than one owner.

Lastly, all business structures must meet certain state requirements to be officially recognized as a business. The requirements for LLCs and S corporations are nearly identical.

How are They Different?

Limited liability companies (LLCs) and S corporations differ primarily in ownership restrictions and a few formalities.

The IRS imposes restrictions on S corporation ownership, but no such restrictions exist for LLCs. These restrictions include:

  • An S corporation can have up to 100 shareholders or owners, while an LLC can have an unlimited number.
  • All S corporation owners must be U.S. citizens and residents, whereas LLCs can include non-U.S. citizens as owners or members.
  • Certain types of businesses, such as other S corporations, C corporations, LLCs, partnerships, or too many trusts, cannot own an S corporation. However, these restrictions do not apply to LLCs.

Furthermore, LLCs are not restricted in their ownership of subsidiaries.

The two structures significantly differ in their formalities.

The internal formalities for both structures vary. An S corporation follows strict internal formalities, while a limited liability company treats internal formalities more like suggestions.

The required formalities for an S corporation include:

  • Adopting bylaws
  • Holding initial and yearly director and shareholder meetings
  • Issuing stock
  • Recording meeting minutes on the corporate record.

The suggested formalities for an LLC include:

  • Establishing an operating agreement
  • Documenting significant company decisions
  • Conducting and documenting annual member meetings
  • Allocating membership shares.

Which Corporate Structure is Right for Your Business?

While there are several differences between the two structures, the most substantial ones lie in management methods and existence duration.

In terms of management, a limited liability company (LLC) with several members may function like a partnership. Conversely, a corporation with few managers may operate more like a standalone business. In an LLC, members typically don’t partake in daily business decisions. An S corporation, on the other hand, must have directors and officers. Directors handle major business decisions, while officers ensure day-to-day operations.

Regarding existence duration, an S corporation can exist indefinitely, while an LLC may have a specified dissolution date.

Stock transfer is generally easier in an S corp, provided IRS restrictions are met. In contrast, transferring stock in an LLC often requires approval from other members.

In many situations, the owners of an S corporation can take advantage of the Qualified Business Income Deduction, which will save on income taxes.

From a tax perspective, an S corporation owner may have better self-employment tax benefits than an LLC owner. This is because the S corporation owner can be treated as an employee, not an owner.

If you still need to decide the type of business entity to create, an experienced corporate law attorney in Atlanta can help you find the best fit for your business.