What’s better an LLC or an S Corp? We explain the Pros and Cons of LLC vs S Corp in simple terms.
An LLC is easier and cheaper to run. But an S Corp pays less tax and could save you a lot of money if you have a big business. S Corps do not pay self-employment tax on company dividends, while LLC companies do.
LLC vs S CORP
What’s better, an LLC or an S Corp? That answer is – it depends on your business. An LLC is a company structure that affords its owners liability protection and pass-through taxation.
This means it protects the owner’s personal assets and allows owners to avoid paying corporate tax on company earnings. An S Corp is a tax status you can elect for a company that allows you to pay less tax.
An S Corp reduces the amount of tax you pay by eliminating self-employment tax on your company distributions. However, S Corps come with additional costs, including accounting, payroll, and formation costs.
For an S Corp to be cost-effective your company needs to be able to pay you a reasonable salary and generate a minimum of $10,000 in annual distributions. This will offset the additional costs in terms of running an S Corp.
WHAT’S THE DIFFERENCE BETWEEN AN LLC AND S CORP?
An LLC and an S Corp are two very different things. An LLC is a legal business entity. It is a form of business structure used to run a company. An LLC is recognized as a legal entity separate from its owners.
On the other hand, an S Corp is a tax classification. An LLC or a corporation can choose to be taxed as an S Corp if the company meets certain requirements. An LLC can elect to be taxed as an S Corp.
WHAT IS AN LLC?
An LLC is a type of business structure. It is recognized as a legal entity and that creates a separation between the company and its owners.
The main advantages of forming an LLC are its limited liability protection and its pass-through taxation regime. Limited liability means that the assets of the company’s owners are protected from company debts.
And, pass-through taxation means company earnings are passed to owners in full without having to pay corporation tax. Instead, owners pay income tax on any earnings received.
WHAT IS AN S CORP?
An S Corp is a tax classification. It is not a business entity. The ‘S’ stands for subchapter, so an S Corp is a subchapter corporation. An LLC can choose to be taxed as an S Corp if it meets certain requirements.
If an LLC chooses to be taxed as an S Corp it will continue to benefit from pass-through taxation. And, an S Corp reduces your company’s tax liability by eliminating employment tax paid on dividends and distributions.
However, forming and running an S Corp comes with additional accounting and payroll costs. If you are considering forming an S Corp you will need to weigh up any potential savings against these additional fees.
LLC vs S CORP
- WHEN SHOULD YOU CHOOSE S CORP
- LLC ADVANTAGES DISADVANTAGES
- S CORP ADVANTAGES & DISADVANTAGES
- COMPARISON OF KEY FEATURES
- S CORP FORMATION REQUIREMENTS
- FREQUENTLY ASKED QUESTIONS
WHEN SHOULD YOU CHOOSE S CORP?
When weighing up the potential benefits of LLC vs S Corp – there are a few factors you need to consider. In general, S Corps work best for larger businesses or for small businesses that plan to scale up.
An S Corp comes with additional accounting costs, payroll systems, and tax forms. If you own a small business and don’t want to take on the additional costs and hassle – then sticking as an LLC may be your best option.
However, if you weigh up the costs of forming an S Corp and they are significantly outweighed by potential savings in tax – then an S Corp is for you. An S Corp eliminates the self-employment tax an LLC has to pay on company dividends. For more see the Tax Benefits of an LLC.
An S Corp comes with some additional benefits that may influence your decision. Forming an S Corp will allow you to contribute pre-tax dollars to health insurance and retirement 401(k) plans.
If you are considering choosing S Corp tax classification for your LLC we advise hiring an accountant to help you make the decision. An accountant will run through your company numbers and offer professional advice on the best course of action.
LLC ADVANTAGES & DISADVANTAGES
What are the advantages and disadvantages of an LLC compared to an S Corp? Let’s take a look at the pros and cons of an LLC business structure and how that compares to an S Corp.
LLC ADVANTAGES
1: LIABILITY PROTECTION
The main advantage of forming an LLC is liability protection. AN LLC is recognized as a legal entity that is separate from its owners. It offers protection to the personal assets of the owners should the company ever be sued or run up a debt.
Electing S Corp tax status for your LLC will not affect your liability protection. An LLC that chooses to be taxed as an S Corp will retain liability protection for its members.
2: PASS-THROUGH TAXATION
Another key benefit of an LLC is its pass-through taxation status. All profits earned by an LLC are passed through to its members without being subject to income tax. The earnings are then taxed as part of each member’s individual income tax return.
Electing to S Corp taxation status for your LLC will not affect this tax regime. You will continue to benefit from pass-through taxation exactly as you did before choosing to switch to S Corp status.
3: CHEAPER TO RUN
An LLC is cheaper to run than an S Corp. If you form an S Corp you will encounter additional fees in the form of accounting and payroll costs. These services are required to run an S Corp company.
In general, you can expect these additional costs to be in the region of $2,000 per year. Operating an LLC will save money in terms of operational costs.
4: SIMPLER MANAGEMENT STRUCTURE
Management structure is an important feature when weighing up an LLC vs S Corp. And, an LLC has a much simpler management structure compared to an S Corp.
LLCs are managed in the same way as a sole proprietorship or partnership. S Corps on the other hand are run by a board of directors that are elected by company shareholders.
The directors then appoint officers to handle the day-to-day affairs of the company. An LLC is either run directly by its owners or by managers they appoint.
5: FLEXIBLE OWNERSHIP STRUCTURE
An LLC company has a more flexible ownership structure and is not subject to the same restrictions as an S Corp. An LLC can have an unlimited number of owners from anywhere in the world. These owners can be individuals or other corporate entities.
An S Corp can have a maximum of 100 owners, known as shareholders. And these owners must be US citizens or special types of US-based trusts or estates.
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LLC DISADVANTAGES
1: SELF EMPLOYMENT TAX
The main disadvantage of an LLC is that you will have to pay income tax and employment tax on any company distributions or dividends received. An S Corp does not pay any employment tax on company distributions or dividends.
Employment taxes cover your social security and medicare tax and work out at 15.3%. This is a significant chunk out of your company profits. And, as your business grows this figure becomes much more significant.
2: PRE-TAX CONTRIBUTIONS
An LLC does not allow you to contribute pre-tax earnings to your healthcare or 401(k) pension plan in the same way as an S Corp does. If you want to ability to invest pre-tax earnings – an S Corp offers better opportunities. For more information check out – Advantages & Disadvantages of LLC.
S CORP ADVANTAGES & DISADVANTAGES
What are the advantages of electing an S Corp tax designation for your LLC? Do the benefits outweigh the disadvantages? Let’s take a closer look at the pros and cons of S Corp.
S CORP ADVANTAGES
1: PAY LESS TAX
When assessing an LLC vs S Corp, the biggest advantage of an S Corp is the reduction in tax liability. When you form an S Corp you will no longer have to pay employment taxes on company dividends.
Employment taxes represent social security and medicare tax. They are charged at a rate of 15.3% on company distributions. As your company grows this figure will become more significant.
2: INVEST PRE-TAX EARNINGS
Forming an S Corp will allow you to invest pre-tax earnings in healthcare insurance and your 401(k) retirement plan. This means you can make larger contributions using funds that have not been subjected to tax.
3: GREAT FOR BIG BUSINESSES
S Corps work well for large businesses that generate significant earnings. Eliminating the employment tax on these large dividends is more significant than it is for a smaller company.
When electing S Corp classification you need to weigh up the potential tax savings against the increased maintenance costs of running an S Corp. And, S Corps are a good fit for large companies and businesses that expect to grow.
S CORP DISADVANTAGES
1: INCREASED RUNNING COSTS
Running an S Corp comes with increased maintenance fees compared to an LLC. Once you form an S Corp you will encounter increased payroll and accounting fees. These are the costs of running a company as an S Corp.
The increased cost of running an S Corp will vary depending on the nature of your business and the state you are registered in. But, you can expect to be hit with at least an additional $2,000 in payroll and accounting fees.
2: SEPARATE TAX FILINGS
An S Corp requires the submission of a separate tax filing. This represents additional paperwork and hassle. If you want to avoid preparing a separate tax filing you may prefer to stick with an LLC for now.
You can always revisit the possibility of forming an S Corp if the company continues to grow and crosses a critical income threshold that justifies forming an S Corp.
3: OWNERSHIP RESTRICTIONS
An S Corp is subject to some strict ownership restrictions that do not apply to an LLC. An S Corp company must be a US business owned by U. Citizens. And, it can have a maximum of 100 owners – known as shareholders.
An LLC on the other hand can have an unlimited number of owners. Also, the owners of an S Corp cannot be an entity, corporation, partnership, or non-resident alien. Owners of an S Corp can however be company employees – just like an LLC.
4: FORMATION COSTS
If you own an LLC and want to change to an S Corp you will have to pay a formation fee. The amount you will pay depends on the state you are forming in but you can expect to be in the region of $50 to $500.
KEY FEATURES COMPARISON – LLC vs S CORP
COMPANY FORMATION
To elect S Corp status you will first have to form an LLC – if you have not already done so. The cost of forming an LLC varies from state to state.
The filing fees vary from $50 to $500. Once you have your LLC formed you can elect S Corp status assuming your company meets all the S Corp formation requirements.
The cost of forming an S Corp varies from state to state but you can expect to pay in the region of $100 to $250. This does not include any accounting or lawyer fees – and it is good practice to seek professional advice before forming an S Corp.
MANAGEMENT STRUCTURE
Management structure is an important consideration when assessing the benefits of an LLC vs S Corp. LLCs have a much simpler management structure.
An LLC company can either be run by its owners or by an appointed manager or group of managers. If an LLC is run by its owners it is known as a member-managed LLC. If it is run by managers, it is known as a manager-managed LLC.
On the other hand, an S Corp is run by an elected board of directors. The company shareholders elect a board of directors who in turn make decisions on how the company is to be run.
The board of directors may appoint officers to handle the day-to-day running of the company. Officer positions include company president, vice president, and treasurer.
COMPANY OWNERSHIP
Company ownership is an important consideration when deciding if an LLC or S Corp is better for your business. An LLC offers greater flexibility and simplicity. In terms of ownership, they are operated the same way as either a sole proprietorship or partnership.
An LLC can have unlimited members from anywhere in the world. And, these owners can be another corporate entity.
On the other hand, an S Corp must be a US business owned by US citizens. And, it is limited to having a maximum of 100 owners. An S Corp can only be owned by a US citizen or certain types of US-based trusts and estates. It cannot be owned by another corporate entity.
SHAREHOLDERS & STOCK
An LLC has no shareholders. It either has a single member that is entitled to 100% of company profits. Or, it has a group of members that share the profits between them.
If an LLC has multiple owners an operating agreement is written to formally declare how the profits will be distributed amongst the LLC members.
An S Corp employs a very different system for distributing company profits. S Corps issue common stock to its shareholders. And, company profits will be distributed in line with these shares. Shareholders also have voting rights when it comes to the running of the company.
TAX
How do the tax requirements stack up for an LLC vs S Corp? The tax regime of an LLC company mirrors that of a sole proprietorship. It benefits from pass-through taxation.
All company profits are passed through to the LLC owners without being subjected to business tax. The owners then pay income tax and employment tax on these dividends.
An S Corp has a significant tax advantage compared to an LLC. S Corp companies do not pay self-employment tax on company dividends. Employment tax is charged at 15.3% – a significant chunk of your company earnings.
If you own a large company that is generating significant profit, an S Corp tax designation could represent large tax savings. However, you need to factor in the additional maintenance costs of running an S Corp.
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S CORP FORMATION REQUIREMENTS
What requirements must be met to form an S Corp? The requirements you need to meet are laid out by the IRS. To qualify for S Corp tax designation your company needs to meet the following requirements.
To qualify for S corporation status, the corporation must meet the following requirements as laid out by the IRS.
- Be a Domestic Corporation
- Have only Allowable Shareholders
- Have no more than 100 Shareholders
- May be Individuals, certain Trusts, and Estates and may not be Partnerships, Corporations, or Non-Resident Alien Shareholders
- Not be an ineligible Corporation
- Have only One Class of Stock
To become an S Corp you must submit Form 2553 Election by a Small Business Corporation. The form needs to be signed by all the company shareholders and filed with the IRS.
LLC vs S CORP FAQ
WHAT IS BETTER S CORP OR LLC?
S Corp is a tax designation that comes with several benefits. For example, an S Corp does not pay any self-employment taxes on company dividends.
However, an S Corp is more expensive to run than an LLC. In general S Corp is better for big companies with large earnings. And, an LLC is better for small companies that want to keep costs down.
DOES AN S CORP HAVE TO PAY SELF-EMPLOYMENT TAX?
S Corp owners do not have to pay any self-employment tax on company dividends. However, if you are receiving a reasonable salary from the company, then you must pay self-employment tax on this salary.
CAN I TURN MY LLC INTO AN S CORP?
Yes, you can turn your LLC into an S Corp if you satisfy a set of S Corp formation requirements as specified by the IRS. Switching to an S Corp will reduce your tax burden as you will not have to pay self-employment tax on any company dividends you receive.
IS AN LLC OR S CORP BETTER FOR TAXES?
An S Corp is better for taxes than an LLC. S Corps do not have to pay self-employment tax on company dividends. LLC companies do. However, S Corps come with additional operational costs.
SHOULD I SWITCH MY LLC TO AN S CORP?
Switching your LLC to S Corp is a good idea if the amount of money you save in reduced taxes is greater than the increase in costs in forming and maintaining your S Corp. However, we recommend you consult a professional to help you assess your business and advise you on the best course of action.
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About the Author
Jason Roth: Editor in Chief
Jason is editor in chief at My LLC Guide. He holds a wealth of business management experience and has been advising companies on business formation issues for many years. Jason specializes in resource planning management, staff utilization, and productivity consulting.
He has worked predominantly in the west coast area where he graduated from the Marshall Business School at the University of South California. When he’s not working in his business advisory role, Jason likes to climb on his Indian Scout motorbike and enjoy the open road.