Comparing S Corp vs. LLC: Key Differences

an llc owner the phone with an s corp owner discussing key differences

S Corps and LLCs are great ways to organize a business, each offering liability protections to the owners. Each has different standards, for it is ownership structure and how it conducts formal business, but either way, you have a pass-through entity that confers many strategic tax benefits.

Still, both organizational forms are very different in terms of management and total tax benefits. Understanding the key differences will help you evaluate the corporate form that you find most beneficial.

What Are These Two Business Structures?

Businesses are generally structured in four ways: sole proprietor, LLC (which includes partnerships), S Corps, and C Corps. Each of these entities starts at the state level of filing, although a sole-proprietor business does not need to be filed.

LLCs and S Corps are the two business forms called “pass-through entities.” Pass-through means the owners benefit from limited liability, but the gains and losses flow through to them, and taxes are not paid or losses recouped at the company level.

What Is an S Corp?

A sub-chapter S corporation is an entity recognized explicitly at the federal level by the IRS.

When a business is filed with the state as a Corporation (C Corp), or any entity eligible to be treated as a corporation, it can then use IRS Form 2553 to elect S Corporation tax status [1]. The form must be filed within 2 months and 15 days of the start of the tax year in which the election is to take effect. The IRS may take some time to process the form, and once approved, the election can be retroactive to the start of the tax year in which the form was filed. Until confirmation from the IRS is received, it is advisable to operate as an S Corp for tax purposes.

What Is an LLC?

An LLC can be a single-owner LLC, a partnership, an LLC with many owners, or a professional LLC (PLLC) where doctor or lawyer members come and go and is initially filed and recognized by the state where it operates. Like an S Corp, an LLC is a pass-through entity where the gains or losses flow to the owners based on their ownership percentages.

Unlike an S Corp, the standards for board meetings and other formal filings do not exist, making an LLC far more accessible to manage but also doing so at a potentially higher tax rate for active owners within the company.

What are the Similarities Between LLCs and S Corps?

LLCs and S Corps offer two significant advantages to owners: liability protection and pass-through taxation. Liability protection is fabulous but only extends as far as an owner personally endorses a liability, although the other owners are protected.

an S corp owner on the phone with an LLC owner discussing the similarities between the two business types

Pass-through income is a benefit granted to all owners of either business type in that they get to claim income or losses on their personal tax returns. Owning a pass-through entity prevents double taxation, as only the owner is taxed in accordance with the percentage of ownership allocated to the profits. [2] Additionally, losses pass through to the owner and may be used to reduce or eliminate tax liabilities.

Key Differences in Ownership & Management

The two pass-through entities have many similar benefits but differ in how ownership exists and management and oversight are conducted. While an LLC is straightforward, an S Corp might be far more complex.

Ownership Distinctions

An LLC solely specifies that the business is filed as such, and the initial and ongoing filings with the Secretary of State will only clarify management and partners. In addition to yearly filings, very little is legally required.

Beyond those routine filings, an LLC should have an Operating Agreement that specifies how owners gain or lose ownership, when distributions are granted, their ownership percentages, how major decisions are made, and what happens in the event of a member’s death or incapacitation.[3]

Most LLCs dissolve in the event of the death of an owner.

S Corps are very different in that owners hold shares of stock in the company, not contractually defined percentages. There is no operating agreement among owners; instead, a specified organizational structure, scheduled board meetings, and agreed-upon manners are used to determine specific actions. Overall, the S Corp must maintain bylaws, keep its list of officers updated with the state, and maintain records of regular board meetings. Much more record keeping and reporting is required of an S Corp.

If an owner dies, the S Corp will not automatically dissolve as the stock may be easily inherited or sold unless the bylaws place particular restrictions, such as the company has first right of refusal to buy back the stock.

Overall, ownership in LLCs versus S Corps comes down to contractual percentages versus shares of stock.

Management Variances

LLC management is simple. It can be as easy as having a managing partner, or every executive role could be defined. The management structure comes down to the wishes of the collective ownership. Most likely, the majority owner acts as the managing partner, but that isn’t always the case.

An S Corp could be more detailed in its ownership, presenting an executive and board of directors structure in its bylaws. Any corporation will generally exist under the requirement that the bylaws are filed with the state, whereas this is not an LLC requirement. Therefore, the management structure is not as flexible or undefined as an LLC. 

Tax Considerations

an s-corp and llc owner standing back to back

Both LLCs and S Corps are pass-through entities, and they both offer tremendous tax benefits to their owners. They provide the same tax benefits in almost every regard, but one significant benefit comes with an S Corp.

That is the ability of owners working in the business and paying themselves a reasonable wage to avoid payroll liabilities on their earnings beyond a reasonable salary.

For instance, if a shareholder with greater than two percent ownership is also acting as the head of the company daily and paid a fair wage, any distributions beyond that wage will incur no self-employment taxes.

Ongoing Formalities and Compliance

As previously mentioned, the ongoing maintenance of an LLC is usually straightforward. If nothing changes year over year, the owner or owners will simply re-attest as much in the subsequent year’s business filings.

An S Corp requires significantly more maintenance in that the board meetings must be held and documented and any bylaws changes determined by the board must be filed with the state. If the executive structure of the corporation changes, the state must be notified.

Structuring Choices & Determining the Right Fit for Your Business

An LLC is fabulous for a smaller business with a few owners who generally pay themselves a wage and take small distributions.

Beyond that scenario, even if a company has only one sole owner, it should be an S Corp if profits are high enough that significant distributions will be paid beyond a reasonable wage, as the tax savings can total 15.3 percent of self-employment tax savings saves owners significant money.

It is very safe to say that any LLC paying its owners significant distributions beyond their salaries should change their status with the IRS to an S Corp and save the owners all self-employment taxes beyond their general wage.

RCReports specializes in helping S Corp owners and CPAs determine reasonable compensation, keeping them out of trouble with the IRS while maximizing their savings on employment taxes.

Get a demo from RC Reports today to know what reasonable compensation is for your role in the company and industry.

Sources

 

1. Internal Revenue Service. (n.d.-a). About Form 2553, Election by a Small 

Business Corporation. https://www.irs.gov/forms-pubs/about-form-2553

A corporation or other entity eligible to be treated as a corporation files this form to make an election under section 1362(a) to be an S corporation.”

2. Lasker, R. (2022, May 18). A Small Business Guide to Pass-Through Entity 

Types. The Ascent. https://www.fool.com/the-ascent/small-business/articles/pass-through-entity/

“Most small businesses organize as pass-through entities to avoid double taxation and the colossal list of administrative rules that come with owning a C corporation.”

3. What is an Operating Agreement? Do I Need One for my LLC? (2023, November 9). Thomson Reuters Legal. https://legal.thomsonreuters.com/en/insights/articles/what-is-an-operating-agreement

4. Joshi, I. (2020, September 4). Does my Company Lose its S-Corp Election if a Shareholder Dies? Dunlap Bennett & Ludwig. https://www.dbllawyers.com/does-my-company-lose-its-s-corp-election-if-a-shareholder-dies/

“When a shareholder dies, his or her shares in the S-Corp will be inherited according to the deceased shareholder’s will and/or living trust, or the state’s intestate laws. S-Corps cannot have irrevocable trusts or estates as shareholders; it ruins eligibility. Loss of S-Corp eligibility is not absolute.”

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