LLC vs. S-corp: Which is best for your business? (2024)

Business entity type and tax structure impact your organization’s finance and compliance requirements. Two popular choices are limited liability companies (LLCs) and S-corps.

Although the arrangements share characteristics, distinct differences exist between them. Notably, an LLC can opt for S-corp classification for tax purposes. Therefore, it’s essential to compare LLC vs. S-corp options when forming your business or reaching a certain profitability level.

We evaluated S-corps versus LLCs by examining regulatory provisions, taxation methods and costs. Our guide identifies the benefits and drawbacks of each option. In addition, we offer recommendations for choosing between the two.

What is an LLC?

LLC pros

• Provides personal asset protection.
• Unlimited LLC members, including non-U.S. citizens.
• Flexible tax and management options.

LLC cons

• Must pay self-employment taxes.
• LLC requirements for dissolution vary by state.
• LLCs don’t pay owners’ or members’ salaries.

A limited liability company (LLC) is a state business structure, meaning the rules vary depending on the state where you form the entity. Most states allow unlimited LLC owners, referred to as members. Corporations, individuals, foreign entities or other LLCs can own single or multi-member entities.

Many entrepreneurs choose an LLC over a sole proprietorship because the entity type protects personal assets, like your home. It can reduce your liability if someone sues your business or when claiming bankruptcy. However, most insurance firms and banks can’t use the LLC structure.

As a pass-through entity, LLC members pay self-employment taxes (Medicare and Social Security taxes) and income taxes on their personal tax returns. This approach simplifies taxes but can be a downside once an individual reaches a certain tax bracket. Since LLC members don’t pay themselves a salary, they can’t take advantage of some health insurance and 401(k) tax benefits.

Still, members decide if the Internal Revenue Service will view the LLC as a disregarded entity, partnership or corporation for taxation purposes. This flexibility means you can alter your status to lower your tax burden at a later date.

Although LLCs require fewer formalities than corporations, issues may arise if an LLC member dies or the owners want to dissolve the LLC.

What is an S-corp?

S-corp pros

• May reduce self-employment tax burdens.
• Personal liability protections.
• Companies can contribute to retirement and insurance plans.

S-corp cons

• Not all companies or owners qualify for S-corp status.
• Only 100 shareholders are allowed.
• Additional federal and state tax requirements.

A subchapter S corporation, known as an S-corp, is a tax election, not a business entity type. LLCs and C-corporations can choose this taxation method if they meet federal IRS eligibility requirements. An S-corp can have a single owner called a shareholder or up to 100.

It limits shareholders to individuals and certain trusts or estates. Shareholders can’t be non-resident aliens, corporations or partnerships. This can be a pro for small business owners who want to restrict ownership. However, a fast-growing company may prefer the flexibility of C-corps and LLCs, as both permit unlimited members.

S-corps retain the personal liability protections afforded to LLCs. Likewise, the IRS views S-corps as pass-through entities. This designation means shareholders report income and deductions on personal tax returns. The S-corporation doesn’t pay federal income taxes but must file an annual form with the IRS.

Corporate officers and shareholders who provide anything more than minor services must receive reasonable compensation. Therefore, shareholders can also be employees. The IRS classifies shareholder-employee salaries as wages for the Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA) and income tax purposes.

The tax benefits of operating as an S-corp are two-fold. First, an individual only pays employment taxes on wages, not non-wage distributions. Business owners can reduce tax burdens by paying themselves a reasonable salary and taking a percentage of profits as a distribution.

Secondly, a company can contribute to an employee’s (or business owner’s) retirement plan and assist with insurance premiums. Eligible payments aren’t subject to FICA taxes and may count as a deduction when figuring corporate profits and losses.

However, S-corps may require more paperwork, and choosing the right strategy is more complex when considering an S-corp over an LLC.

What do an LLC and S-corp have in common?

Before deciding on an LLC or S-corp, consider how the structures are alike. Use this information to weigh the pros and cons of both approaches.

S-corps and LLCs share the following characteristics:

• Liability protections: Both structures limit personal liability, meaning creditors or plaintiffs can only access business assets. They typically can’t come after your residence or personal vehicle.
• IRS eligibility limits: Not all businesses can qualify as S-corps or LLCs. Federal tax regulations restrict insurance companies and some financial firms from operating as LLCs or S-corps.
• Pass-through taxation: Both entities can show business profits and losses on personal tax returns, with individual members or shareholders claiming the tax burden.
• State obligations: Individual state statutes outline reporting, fee and registered agent requirements for LLCs and S-corps. States also define foreign entity rules for companies doing business within state boundaries.
• Business credit: Unlike a sole proprietorship, LLCs and S-corps separate personal and business liabilities. This division can make it easier to establish business credit.

What are the key differences between an LLC and S-corp?

When comparing LLC vs. S-corp entities, far more contrasts exist than similarities. For starters, companies form LLCs through the U.S. state (or states) where they do business, whereas an S-corp is a tax election governed by the Internal Revenue Code (IRC).

Other differences between S-corps and LLCs include:

• Ownership restrictions: Most states let LLCs have unlimited members, whereas the IRS permits no more than 100 S-corp shareholders. Different domestic and foreign entities can be LLC members, but S-corp shareholders can’t be non-U.S. residents or corporations.
• Management options: Owners can run an LLC like a partnership and control daily operations or choose a manager-member to operate like a corporation. Multi-person S-corps have a board of directors to oversee business affairs and elect officers to run day-to-day operations.
• Yearly requirements: Typically, states require less information on an LLC annual report than on an S-corp statement. In addition, corporations should hold board meetings and record minutes. While experts recommend that LLCs hold yearly meetings, it’s not a requirement.
• Profit and loss allocation: S-corps distribute profits and losses according to the percentage of ownership interest. Although this is also the default method for LLCs, members can choose different allocations by documenting them in the operating agreement.
• Salaries: LLC business owners don’t earn a salary. Instead, they take an owner’s draw. S-corporations pay wages to any shareholders (including owners) who provide services.
• Federal taxes: The IRS treats LLCs as pass-through entities by default, but the entity can choose to file as an S-corp or C-corp. An S-corp is also a disregarded entity but it can’t file as a C-corp unless it’s an incorporated structure.

Which is best for your business?

The legal and tax implications can vary significantly between LLCs and S-corps. Discuss options with your financial and tax advisors when comparing LLC vs. S-corp advantages and drawbacks.

When should you choose an LLC?

The best LLC services make it easy for startups and small businesses to set up a limited liability company. However, there are other reasons for forming an LLC.

Circ*mstances when an LLC may be the better option include:

• When your company profits are the same as or close to a reasonable salary for others in your profession.
• If one or more current or potential business owners are not U.S. citizens.
• When your company wants to veer away from the default profit and loss distribution methods.
• Solo business owners and freelancers who prefer simple federal and state tax, payroll and reporting requirements.
• Organizations considering bringing on a foreign investor, corporation or LLC as a stakeholder.

When should you choose an S-corp?

After forming an LLC or incorporating your business, you can elect to be taxed as an S-corp. Business owners and shareholders or members can benefit from this tax status.

An S-corp may be the better choice under the following conditions:

• When you determine it’s possible to reduce your self-employment tax burden by taking a reasonable salary and dividends.
• If owner-employees could benefit from company contributions to retirement or health insurance plans.
• A business considering soliciting external institutional investors may get better results as an S-corp.
• Your company is registered as a C-corporation but meets the requirements to file as an S-corp.

Frequently asked questions (FAQs)