When you choose to start a company, you have a lot to consider. One of the most important parts of starting a business is choosing the right company structure and tax designation for your needs.
There are many types of structures for forming a business, such as partnerships, LLCs and S corporations. Each of these structures comes with its own benefits and drawbacks, and each is suited to different strategies.
If you’re planning to start a smaller business, two of the most effective structures are an S-corp (subchapter corporation) and an LLC (limited liability company). But understanding the differences between these two types of businesses can take some research.
In this article, we’ll explain the differences between LLCs and S-corps and help you understand the benefits and disadvantages of each company structure:
The differences between an S-corp and an LLC boil down mainly to tax classifications. An S-corp is a tax designation that can be applied to a variety of companies, including an LLC, which limits the tax burden on profits.
Still, there are some notable differences in a range of categories that make it important to choose the right structure from the beginning. Here are the main characteristics that make an S-corp different from an LLC:
An LLC operates the same way as a partnership or sole proprietorship. But unlike those structures, an LLC can have an unlimited number of owners (known as members) from any location. Members can even include another company or corporate structure.
An S-corp must be a business based in the United States, and all owners must be citizens of the United States. S-corps cannot have more than 100 owners.
A corporation (including S-corps) is structured around a board of directors. This board makes high-level choices about running the company, such as adding a C-level position and adding or removing a CEO. Under the board of directors are the C-level executives, presidents, and vice presidents. These positions manage the day-to-day operations of the business.
An LLC is run by a manager or a team of managers depending on how the articles of organization are constructed. Because an LLC is governed by the articles of organization, there is much greater flexibility in the management structure.
An S-corp can employ the owner and pay them a salary. An LLC being run as a corporation can do the same. An LLC that turns a profit after paying owners can elect to be taxed as an S-corp, which might help save money on your final tax bill.
Typically, tax considerations for a single-member LLC mirror those of a sole proprietorship. If the LLC has multiple members, then the tax structure will resemble the one used for partnerships. Both single- and multiple-member LLCs can elect to be taxed as either a C-Corp or an S-corp if certain eligibility requirements are met.
An S-corp can issue common stock to give voting rights to shareholders. LLCs cannot issue stock. They pay members based on the methods outlined in the articles of organization.
The state where you are forming your company will have the biggest influence on your establishment cost. In general, LLCs have a lower average formation cost, but a higher maximum cost of establishment (the cost of filing articles of incorporation) when compared to S-corps.
An S-corp is a tax classification that protects small-business owners from being taxed twice. It uses something called pass-through taxation, which is when an owner claims a portion of the company’s profits on their own tax return and then files their return. This prevents profits from being taxed during both the corporation’s filing and the individual’s filing.
S-corp specifically means subchapter corporation. To form an S-corp, you must first form a C corporation and then meet certain requirements to become classified as an S-corp. These requirements include:
An LLC can also become an S-corp if the owner files IRS Form 2553 and elects to use the S-corp tax classification.
An LLC, or limited liability company, is a type of company structure that limits the liability of an owner by cleanly separating the assets of the owner and the company. In an LLC, owners are called members, and an LLC can have one or multiple owners. An LLC with one member is called a single-member LLC.
LLCs are not tax designations, unlike an S-corp. They are more versatile than many other business structures because most of the rules of an LLC are dictated by the organization agreement, which the owner creates when establishing the company.
| Definition | Taxation Rules | Ownership Rules | Management Rules | |
|---|---|---|---|---|
| LLC | A Limited Liability Company is a company that separates private assets from business assets. | LLCs must pay taxes on profits at a rate of 15.3%. | LLCs can have an unlimited number of members with an ownership stake. | An LLC can be run by a team of managers or a single manager. |
| S-Corp | An S-corp (subchapter corporation) is a tax designation that passes company income, deductions, losses, and credits through to shareholders when paying federal taxes. | The owner of an S-corp can be treated as an employee and paid. This allows FICA taxes to be withheld and paid on the owner’s salary. | S-corps can have no more than 100 owners and can only be owned by United States citizens. | An S-corp has a board of directors who oversee the company. |
Both an S-corp and an LLC have powerful benefits if you choose the right structure for your situation. An S-corp is the ideal tax classification if you expect to grow your business significantly. The taxation of an S-corp is more complex than many other business structures require. However, it can position you well for growth and other benefits if you can find a way to make the complexity work for you.
S-corps also benefit growing companies because they don’t incur taxes as high as LLCs do. An LLC has a 15.3% employment tax on its profits, which is very noticeable as revenues increase.
An LLC is a great structure if you want to start a company quickly and protect yourself from personal liability. It also requires minimal upkeep, which makes LLCs great for people who need a quick business organization around them that they don’t have to pay much attention to.
An LLC also offers a lot of flexibility. In fact, you can turn your LLC into an S-corp if you feel that it will be better for your business. LLCs also benefit from simple reporting requirements and greater flexibility of ownership.
You can decide whether it’s better to form an S-corp or an LLC depending on your needs. If you plan to rapidly grow the company and expect to have high profits, then an S-corp will be more suited to your needs. An LLC would likely be a better choice if you want to run a business by yourself and do not plan to add any employees. The LLC structure also works well for multi-member organizations that want to stay small and agile. It’s also worth noting that LLCs are somewhat easier to start than S-corps.
Ultimately, you have to determine which business structure better fits the needs of your organization. Remember, if you change your mind later down the road, an LLC can become an S-corp. Additionally, the S-corp tax designation can be achieved by an LLC.
Someone might choose to create an LLC instead of an S-corp for a number of reasons. Most notably, an LLC is fairly simple to create compared to the majority of business structures.
Also, the S-corp tax designation doesn’t make sense for every business. For example, if you plan to create a company where you are the sole member, then the tax designation of an S-corp doesn’t make sense for your company. In this case, you would want to create a single-member LLC.
An S-corp has some disadvantages. Some of the potential disadvantages include:
In general, if you are choosing between creating an S-corp and creating a single-member LLC, then you’re probably better off forming a single-member LLC. The S-corp tax designation is most effective for companies that generate significant revenue and have multiple employees. This is because an S-corp designation lowers the effective tax rate on profits, but it comes with associated management and maintenance costs that are rarely worth it for a single-member business.
Building a business can be intimidating. If you don’t feel like you have all the information you need about different company structures, or you need advice while trying to form a business for the first time, we can help.
Our experienced business law attorneys know all the ins and outs of creating a company. So you can rely on us.
Call us at (307) 683-0983 to see how we can help you get your business set up the right way.