At first glance, an LLC and an S Corporation may seem very similar. After all, both provide owners limited liability protection. An S-Corp is a type of corporation that qualifies under subchapter S (hence the name) of the tax code, allowing it to be taxed as a partnership instead of a corporation, which is subject to double taxation. LLCs may also elect a similar tax status, except they may do so while avoiding the complex regulations and restrictions that a corporation is subject to.
If you're trying to decide if you should form an LLC or an S-corp, here's a look at how these two business entities differ.
Taxation Issues
One of the biggest downsides to incorporating a business is tax status. Corporations are subject to double taxation, as corporate income is taxed first and then shareholders are liable for income taxes on any dividends they receive. An S Corporation allows certain corporations to be taxed as a partnership instead to avoid the double taxation, provided the corporation can maintain subchapter S requirements. Because an LLC is not recognized as a tax entity by the federal government, it must elect its own business entity classification. LLCs can file as a partnership or a sole proprietorship.
If you're trying to decide if you should form an LLC or an S-corp, here's a look at how these two business entities differ.
Taxation Issues
One of the biggest downsides to incorporating a business is tax status. Corporations are subject to double taxation, as corporate income is taxed first and then shareholders are liable for income taxes on any dividends they receive. An S Corporation allows certain corporations to be taxed as a partnership instead to avoid the double taxation, provided the corporation can maintain subchapter S requirements. Because an LLC is not recognized as a tax entity by the federal government, it must elect its own business entity classification. LLCs can file as a partnership or a sole proprietorship.
This means you can form an LLC and enjoy the same tax advantages of an S-Corp or a sole proprietorship without worrying about strict requirements.
Organizational Differences
An LLC is actually a hybrid structure that many states allow, whereas an S Corporation is a type of corporation that's governed by both state and federal law. The owners of an LLC are referred to as members, and they may be individuals, corporations or even other LLCs. Shareholders of an S Corporation, on the other hand, are not allowed to be partnerships or corporations. An S Corporation is also limited to just 100 shareholders, but there is no limit to how many members an LLC may have.
Regulations
All corporations, including S Corporations, are required to follow strict reporting and record-keeping, and there must be regular meetings of the shareholders and directors. To keep this special tax status, an S-Corp must also continue to meet IRS requirements to keep subchapter S tax status. LLCs are popular with small and large businesses alike in part because there are fewer requirements in terms of reporting and record-keeping, along with organization and filing with the state.
Other Differences
It's worth noting that it is almost always more affordable and faster to form an LLC or partnership than an S Corporation. If you're worried about duration, you may want to opt for an S-Corp or even a C-Corp, as all corporations are separate legal entities from their owners. This means corporations will last forever until they go bankrupt or are merged or purchased. LLCs have a very limited duration, on the other hand, and it is often defined when the LLC is first organized. While members can choose to continue the LLC for a longer term, LLCs will always dissolve if there is a change in ownership.
No one can tell you whether an S Corporation or LLC will be best for your business without knowing a great deal about your goals, structure, profits and more. This is a very complicated decision that should be discussed with an attorney and a corporate service company to weigh the pros and cons and select an entity that will offer the best balance of cost, protection, management structure and tax considerations.
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