S-Corp vs LLC
When You Want More
What are the advantages of an S-corp vs LLC? Can an LLC be an S-corp? In the guide below, we answer these questions and more. We explain the differences between LLCs and S-corps, as well as how the choices you make can affect your business taxes.
Differences Between LLC and S-Corp
What is an S-Corporation?
An S-corp is an IRS tax designation. An S-corp is NOT a business entity.
What does this mean for you? When you file your formation paperwork to create your new business with the state, you can’t “form” an S-corp. Instead, you’ll choose a recognized business structure, like a corporation or an LLC. Then you can change the tax designation of your LLC or corporation by filing paperwork with the IRS.
So, if you file for S-corp tax status, you’ll still have an LLC or corporation. However, your business will be taxed differently—and subject to different rules and regulations.
What is an LLC?
An LLC is a business entity that’s created by filing paperwork (typically called “articles of organization”) with the state. By default, an LLC has the characteristics listed below. Note, however, that many of these characteristics will change if you choose an S-corp tax designation.
Default characteristics of an LLC
- Ownership: Owners are called members. Owners can be domestic or foreign. Owners can also be other businesses like LLCs or corporations. LLCs don’t have stock. Instead, members contribute to the business capital and receive a percentage of membership interest.
- Management: LLCs can be managed by the members directly. Alternatively, LLCs can appoint one or more managers to run the show.
- Formal requirements: LLCs are generally flexible when it comes to formal requirements. For example, annual meetings and formal minutes are optional for LLCs (but required for corporations).
- Operating agreement: The internal rules of an LLC are laid out in a document called an LLC operating agreement. If the LLC doesn’t have an operating agreement, the business will be governed by the default rules found in the state statutes.
- Liability: LLCs have limited liability. This means the business is considered a separate entity from its members. So, the debts and assets of the business belong to the business—not the members. Put another way, if someone successfully sues your business, creditors are typically limited to the assets of the LLC (not your house, car, or personal bank account).
S-Corp vs LLC Chart
When it comes to general characteristics, many things change if your LLC files for an S-corp tax designation with the IRS. These “S-corp vs LLC” differences and more are outlined in the chart below:
|Max number of owners
|Type of owners permitted
Owners must be US citizens or permanent residents. Certain domestic trusts and single-member LLCs can be owners but not corporations, partnerships or multi-member LLCs.
domestic or foreign individuals or businesses, including corporations and LLCs
|Allocation of profits & losses
proportionate to % of ownership
determined by operating agreement (proportionate to % of ownership by default)*
|Owners and income
Owners who provide services for the business are W-2 employees and must receive reasonable compensation. Additional LLC income, beyond salaries, can be categorized as distributions.
Owners who provide services for the business are not considered employees. All LLC income is considered self-employment income.
Applies to salaries but not distributions
Applies to all business income
*Any changes to default allocation percentages must abide by state laws and meet IRS approval.
How do LLC taxes work?
The IRS doesn’t recognize “LLC” as a tax status. Instead, LLCs are taxed as partnerships if they have multiple members. LLCs are taxed as disregarded entities if they have a single member.
LLCs taxed as partnerships and disregarded entities share some common characteristics:
- Pass-through taxation: The LLC itself doesn’t file income taxes like a corporation does. Instead, the income “passes through” to the members. Members then report the income on their personal income tax returns.
- Self-employment income: In the eyes of the IRS, each member of the LLC is a self-employed business owner. This mean members must pay self-employment taxes on ALL of their business income. Self-employment taxes include both social security and Medicare. The combined rate is currently 15.3%.
It’s also possible for LLCs to file paperwork with the IRS to be taxed as a either a C-corp (like a default corporation) or an S-corp.
For more on LLC tax filings, due dates, and election options, see our LLC Taxes page.
How are S-corps taxed?
Businesses taxed as S-corps receive pass-through taxation, just like a default LLC. However, S-corps are little different when it comes self-employment taxes—which can sometimes be a major advantage.
In a default LLC, all income is subject to self-employment taxes. In an S-corp, shareholders can receive income as both salary and distributions. Salary is subject to self-employment taxes. Distributions are not.
However, shareholders can’t just take all the income as distributions to avoid paying self-employment taxes. The IRS requires shareholders who provide services to the business to be paid a reasonable salary. Salaries must be paid before any distributions can be made.
S-Corp vs LLC Tax Savings
An S-corp election can save some LLCs money on taxes—but it depends on your business income.
Generally, LLCs with significant income benefit from an S-corp election. Because of the reasonable salary requirement for S-corps, you’ll want to make enough money to cover the salary costs. Imagine you have a single-member LLC. If your LLC only makes $50K a year, and your salary is $50K a year, you won’t see any tax savings filing as an S-corp.
However, if your LLC makes $100K and your salary is $50K, filing as an S-corp means you could potentially take the remaining $50K as a distribution. That’s $50K you wouldn’t have to pay 15.3% self-employment tax on.
As a result, it’s common for business owners to start an LLC with default taxation and wait to file their S-corp election until they have a regular income nearing six figures.
How to file an S-corp election
You can file Form 2553 with the IRS to make the S-corp election. The election will apply to the following tax year unless you file within the first 2 months and 15 days of the current tax year.
Thinking about starting a new LLC or corporation? We can form your business and file your S-corp election for you at the same time for an additional $50.