Most US entrepreneurs and small business owners set up an LLC when they want to “make it legal”. LLCs are easy and comparably cheap to set up and operate. They can also be tax efficient, especially for entrepreneurs abroad. But they are not the only good choice for a small business structure.
S-Corporations have similarities with LLCs, but also some distinct characteristics, that may be more advantageous for a business.
Let’s compare LLC and S-Corp business structures.
Three things that LLC and S-Corp have in common
Both business structures share some key characteristics:
1. Limited liability protection
The personal assets of the owner(s) are protected against debts, losses, and any court rulings against the business.
2. Separate legal entity
Filing on state level creates a legal entity that is separate from the owner(s). The entity must comply with state-mandated formalities, such as filing annual reports and paying the fees.
3. Pass through taxation
LLCs and S-Corps don’t pay income taxes at the business level. Instead business profit or loss is passed through to the owners’ personal tax returns. Any tax is reported and paid at the individual level.
Six advantages of an LLC over S-Corp
LLCs outperform S-Corporations in some areas:
1. No restriction of ownership
Members of LLCs can be Non-U.S. citizens/residents.
2. LLCs can be owned by a corporation
Also, certain types of trusts can own an LLC.
3. LLCs can have subsidiaries without restriction
4. Less paperwork
Internal formalities are recommended but not required for LLCs (although this can be a disadvantage as it often leads to a lack of documentation of agreements and business decisions).
5. Flexibility in management
6. Less complicated taxes
An LLC is either recognized on the Schedule C of an individual return or as a partnership if multiple partners, whereas an S-Corp always must file an 1120S. An individual owner of an LLC does not pay unemployment or disability taxes, but that also means that the owner is not entitled to state unemployment or disability benefits. They are also not required to take a minimum salary and deal with payroll taxes.
Three advantages of an S-Corporation over LLC
Areas where an S-Corporation is better than an LLC”
1. S-Corporations can sell stock
S-Corp stock can be traded freely as long as IRS requirements are met. An LLC by comparison can only sell interest in the company.
2. Appeal to investors
This is not only due to its ability to issue stock, but also because S-Corps have a more rigid management structure and more extensive reporting requirements. Those required formalities include adopting bylaws, holding initial and annual director and shareholder meetings, and keeping meeting minutes with corporate records.
3. Reduced self-employment tax.
An S-Corporation can pay a reasonable salary to its working owner(s), which is a deductible business expense. This will limit the amount of self-employment taxes (Social Security and Medicare taxes) that is due, as it is only applicable to the amount of salary taken. The remaining net income of the S-Corp is considered a distribution and not subject to self-employment tax. This is the main advantage why people choose an S-Corp as business structure.
LLC vs S-Corp – Which is the best structure for your business?
As you can see, there are various points to consider when selecting a business structure. Many entrepreneurs start out with an LLC and switch later to an S-Corp. Read more here about when you should to convert from LLC to S-Corp.
We offer services to set up a tax-efficient business structure and prepare business tax filings. If you need help to determine and set up the best legal structure for your small business and subsequent tax filings, please contact us for a consultation.