Updated June 1, 2020
Choosing a business structure is a big deal as the entity type you choose can have a large impact on your business. S Corps and LLCs are two of the most popular options but choosing the best corporate structure for your business requires you to understand the differences between the two.
Credibly breaks down the pros and cons of both so you can make an informed decision.
What Are the Advantages of an LLC?
An LLC, or limited liability company, is a type of business in the United States in which the owner(s) are not personally responsible for the company’s debts or liabilities. In general, business operations tend to be much simpler and there are fewer requirements for establishing an LLC. LLCs allow for unlimited owners and are the simplest way of structuring your business to protect your personal assets in the case that your business is sued.
Limited liability companies are very easy to create, making them the most popular legal business structure that offers flexibility and personal liability protection. Setting up an LLC typically takes one to four hours depending on your specific state requirements.
LLCs benefit from very little restrictions, the ability to change their tax structure and have unlimited partners or members, good privacy protection, and flexibility in the way profits and losses are allocated amongst members..
On the other hand, LLC owners are required to pay additional fees and taxes (including self-employment taxes and payroll) and some states have additional fees. Also, LLCs place restrictions on transferability. Consent of membership is required for each and every transfer of membership interests, and an LLC may even have to be dissolved upon the death or bankruptcy of a partner. Additionally, because LLC’s cannot issue shares it can be more difficult raising outside capital.
What Advantages Does an S-Corp Have Over an LLC?
An S Corp, or S Corporation, is a business that passes corporate income, losses, deduction, and credit through shareholders for federal tax purposes, Like LLCs the owners of S corps have the benefit of limited liability, meaning that their personal assets are protected, but they don’t have to worry about double taxation.
Along with not having personal liability for the business debts and liabilities of the company, S corp owners also have favorable tax benefits. S corporations do not have to pay federal taxes and shareholders can be employees of the business that receive salaries, as well as dividends and other tax-free distributions for their investment in the corporation.
One major disadvantage of establishing an S Corporation is the cost of formation. This corporate structure often has a large setup and ongoing fees and requires significantly more effort, including having to file Articles of Incorporation and obtaining a registered agent for your business. Furthermore, there are strict guidelines from stock ownership restrictions and closer IRS scrutiny to less flexibility in allocating income and loss.
S Corp and LLC Similarities
Both S Corps and LLCs have certain advantages over other business structures with the main benefit being the protection they provide the owners’ personal assets from business creditors. In other words, owners are protected against business debts and liabilities that other business structures would hold them liable for.
Additionally, S corps and LLCs avoid paying both personal and corporate taxes, and both business structures qualify the owner to deduct pre-tax expenses. That said, S corps are pass-through entities which means that all income and expenses from the business get reported on the LLC operator’s personal income tax return. Generally, both S Corps and LLCs are pretty friendly when it comes to what taxes you have to pay and what taxes you can avoid.
LLC vs S Corp vs C Corp
A C Corp, or C Corporation, is a legal structure for a corporation in which the owners or shareholders are taxed separately from the entity. C corps are subject to corporate income tax and the taxing of profits from the business happens at both corporate and personal levels creating a double taxation situation.
A C Corp differs from an LLC and S Corp in that it provides more flexibility in selling stock to outsiders as taxes are paid on earnings before distributing remaining amounts to shareholders in the form of dividends. Individual shareholders are then subject to personal income taxes on the dividends they receive. Generally, most small businesses are better off as an LLC or S Corp, whereas big businesses tend to benefit from establishing their business as a C Corp.
Is It Better to Be an S Corp or LLC?
When choosing between an S Corp and an LLC for your business, there are a few things to consider. LLCs tend to be easier, less expensive to set up, and are simpler to maintain and comply with as there are fewer restrictions and regulations. Alternatively, S Corps are preferable if your business is seeking outside financing or aims to eventually issue common stock. While it is possible to change your business structure, you may incur a tax penalty in doing so. Because of this, we recommend carefully thinking about which structure is the best fit for your business prior to establishing your legal business structure.