LLC vs. S Corp: Which Business Structure Is Right for You?
When setting up your small business, you generally have five options: sole proprietorship, partnership, limited liability company (LLC), S corporation, or C corporation. Two of the most popular choices for small businesses are LLCs and S corporations.
LLC vs. S Corp: An overview
When choosing between an LLC and an S corp, the right structure for you depends on your unique circumstances.
Here’s an overview of each:
What is an LLC?
An LLC offers more legal protection than a sole proprietorship or partnership because members of an LLC aren’t personally liable for the business’s debts and liabilities. The rules for establishing an LLC varies by state, but typically you need to file Articles of Organization with the Secretary of State. LLCs can have an unlimited number of members, and those members can be foreign individuals as well as other businesses.
LLC members are considered self-employed. They don’t receive a paycheck or have income or payroll taxes withheld. Instead, they receive compensation in the form of draws and make quarterly estimated payments of income and self-employment taxes.
What is an S corporation?
S corporations are also known as subchapter S corporations or small business corporations. It’s a special tax status granted by the IRS.
S corps provide the legal protection of a corporation because corporations are separate legal entities apart from their shareholders. However, the S corp status allows the company to be taxed like a partnership or LLC and avoid the double taxation issue that owners of C corporations face.
The IRS has strict rules about who can be a shareholder of an S corp. S corps cannot have more than 100 shareholders, and those shareholders must be U.S. citizens or permanent residents. An S corp cannot have another business entity as a shareholder.
S corp shareholders are considered employees of the business and receive a paycheck with income and payroll taxes withheld. If shareholders take additional money out of the company, it’s treated as a distribution, which decreases their share of equity in the business.
For more information on salaries, draws, and distributions, be sure to check out my article on how to pay yourself as a small business owner.
LLC vs. S Corp Taxes
Both LLCs and S corporations are “passthrough” entities, meaning the business doesn’t pay federal income taxes on its profits. Instead, the owners pay taxes on business profits on their individual tax returns.
S corporations file a federal tax return using Form 1120-S. Each shareholder receives a Schedule K-1, which reports the income and deductions that are passed through to each shareholder.
LLCs, on the other hand, have a few options for filing a tax return.
- Schedule C. Single-member LLCs (that is, an LLC with only one member), don’t file a separate tax return for the business. Instead, the business owner reports business income and expenses on Schedule C, which they file along with their personal tax return, Form 1040.
- Form 1065. Multi-member LLCs (that is, an LLC with more than one member) may file the same form used by partnerships, Form 1065. Each member of the LLC receives a Schedule K-1, which is used to report their share of the company’s profits on their personal tax return.
- Form 1120-S. Both single-member and multi-member LLCs can elect to be taxed like an S corp by filing Form 2553. Once the IRS accepts the election, the company files its return using Form 1120-S.
- Form 1120. LLC members also have the option of electing to be taxed like a C corp by filing Form 8832. Once the IRS accepts the election, the company files its tax return using Form 1120.
There are a lot of advantages and disadvantages to structuring your small business as an LLC vs. S corp vs. C corp. If you’re not sure which one is right for you, feel free to set up a call with me! I can help you review your goals and weigh the pros and cons.
