Deciding which business structure to use for a company is an essential step in starting a new business. And, as your business grows, it’s a question that may repeat itself as you work to accommodate your needs and minimize your financial liability.
At CFE, we work closely with our business members to help them protect themselves financially. One of the most common questions we hear is about LLC vs. S Corp structures. What are the key differences?
Here we’ve laid out the five differences between the LLC vs. S Corp structures that may help you decide how to incorporate your business.
#1: Foreign Ownership
If you or one of your partners is not a United States citizen or not a United States resident, the choice of an LLC vs. S Corp may be an easy one. United States Law prohibits non-US citizens and non-US residents from being shareholders in S corporations.
By contrast, non-citizens and non-residents may be named as members in an LLC. In other words, if you and any partners are all citizens, you may choose either option. However, if someone who isn’t a citizen or resident is involved, the LLC is the only option available to you.
#2: Flexibility in Taxes
One of the most significant differences between LLCs and S corps is in taxation. An S Corporation is automatically taxed as a corporation – there is no other alternative. By contrast, if your business is an LLC you have some flexibility in terms of how you pay taxes.
By default, the IRS taxes single-member LLCs as sole proprietorships and multi-member LLCs as partnerships. However, an LLC may also choose to be taxed as either an S Corp or a C Corp. In other words, incorporating as an LLC gives you far more flexibility with taxes than incorporating as an S Corp. That may be enough to swing the decision in favor of the LLC structure for some business owners.
It is important to note that not every LLC will qualify to file taxes as an S Corp. If any of the following apply to your business, you must be taxed as an LLC.
- A foreign LLC
- Owned by a non-resident alien
- Owned by a corporation or partnership
If you’re uncertain about your eligibility, ask the IRS directly.
#3: Taxable Income
Speaking of taxes, the choice between an LLC and an S Corp will have a significant impact on your personal tax liability. If you incorporate an S Corp, you may draw a reasonable salary and you will be taxed on your salary as income, just as you would if you were employed by any corporation.
On the other hand, if you are an LLC member filing as an LLC, you will pay self-employment taxes, meaning that you will pay both the employer’s and the employee’s share of Medicare and other taxes. You’ll also be required to report company profits as personal income, and you will be taxed on them.
In a corporation, business profits are not reported on the owner’s personal tax return. They must, of course, be part of your business tax return.
#4: Business Formalities
Because there are key differences in the operation of LLCs and S Corps, there are some differences in what your formal obligations will be. For example, if you choose the S Corp structure, you’ll need to:
- Adopt bylaws
- Issue stock
- Hold initial and annual meetings for the directors and shareholders
- Keep meeting minutes with your corporate records
If you incorporate as an LLC, on the other hand, you’ll need to:
- Draft and adopt an operating agreement
- Issue membership shares
- Hold annual member meetings and manager meetings, if the LLC is manager-managed
- Document any major company decisions
As a rule, the formalities required of an S Corp are more complex and comprehensive than those required of an LLC. You should keep that in mind when choosing a structure for your company.
#5: Business Operations
The final key difference between an LLC and an S Corp is in the daily running of the business. An LLC may be either member-managed or manager-managed. If it is member-managed, the management may seem more like a sole proprietorship or partnership than a corporation. If it’s manager-managed, then it may seem more like a corporation.
By contrast, an S Corp must have a board of directors. The board will be responsible for electing officers, including a President, Secretary, and Treasurer. The officers (but not the directors) will be responsible for the day-to-day operation of the business.
While there are some important differences between LLCs and S Corps, both structures offer you liability protection to minimize your personal liability for business debts. You should weigh the other differences we’ve outlined here to decide which structure is best-suited to your needs.
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