What Are the Differences Between LLCs and S-Corps?
LLCs and S-Corps are both legal structures that business owners can use to protect their financial interests. While these two terms are used together as a comparison, they are not mutually exclusive. If you’re starting a new company, you may want to use one or both of these tools.
The Basics of an LLC
The Limited Liability Company, or LLC, is a legal entity that shields the owners of a business from many of the liabilities incurred by its activities. In many ways, an LLC is very similar to a regular corporation. Both are, legally speaking, whole entities that can be taxed by the government and sued by other persons and companies. The owners of a corporation are its shareholders, which can include investors from the public at large. The owners of an LLC are its private owners, who may also be referred to as shareholders.
To form an LLC, you’ll need to follow the laws set by your state. Most jurisdictions will require you to create formation and operation agreements and have those agreements certified by the state. All initial owners will need to approve and sign these documents. Tax identifications and public information reports may also need to be filed.
The Basics of an S-Corp
An S-Corp, or S corporation, is a legal tax classification. According to the IRS, S-Corp businesses pass their “income, losses, deductions, and credits through to their shareholders for federal tax purposes.” This helps companies avoid double taxation, which can occur when both the company and shareholders get taxed for the same things. To qualify for S-Corp status, a company must:
- Be incorporated in the United States
- Not have more than 100 shareholders
- Only have eligible shareholders: individuals and limited estates and trusts
- Have only one class of stock ownership
To earn S-Corp status, all of the shareholders of a company must complete Form 2553 Election by a Small Business Corporation.
The Key Differences Between LLCs and S-Corps
Since LLCs and S-Corps are commonly mentioned together, it’s important for businesses to understand what goals each structure accomplishes, even if they’re used at the same time. Each tool benefits businesses in certain ways and may even disadvantage them in others. Both options protect the financial interests of their owners, but how that’s done can have a variety of long-term effects.
Ownership
Almost anyone or any entity can be an owner, or member, of an LLC. This includes foreign nationals, trusts and even other corporations. There is no limit to the number of members. When an LLC obtains an S-Corp status, however, these requirements change. The S-Corp can only have 100 owners, and these owners must be U.S. citizens or domestic trusts.
Management Structure
LLCs have a wide range of options for how to structure their management. Members can act as directors or they can hire non-owner managers to run day-to-day operations. Depending on the state, an S-Corp may require a board of directors. The board can hire presidents, vice presidents, treasurers and other titles. Some jurisdictions do not recognize a difference between S-Corps and other corporations when it comes to management structure.
Tax Liability
LLCs are taxed by states and the federal government as proprietorships or partnerships if no other tax designation is acquired. In an S-Corp, owners can choose to be treated as employees of the company for tax purposes to avoid some self-employment taxes. This can help pay for health insurance, retirement accounts and other employee-related benefits. Profits are then passed through the corporation to the shareholders.
Establishment Costs
Since LLC rules vary from state to state, your cost to establish a limited liability company can range from $50 to $500. The fees to incorporate as an S-Corp can range from $100 to $250. You’ll need to file paperwork for each state your company plans to conduct business in. It’s possible to establish these structures on your own, but a professional legal service or representative is recommended.
Make LLCs and S-Corps Work for You
Whether or not you should use an LLC or S-Corp for your business will depend on your company’s unique situation. Unfortunately, there is no one-size-fits-all solution. You should consider how many owners you have, where those owners live and how the owners want their taxes collected. You should also consider how fast your business may grow, as exceeding the limitations of an S-Corp or LLC can happen quickly. What may work in one state may not work in another, and it will be necessary to find the options that all shareholders agree to.
If you decide to make your business an S-Corp, go to professionals who will help you file your paperwork quickly and with a track record for success. It’s the key to protecting your financial interests and improving the chance of your company’s success.
