LLC vs S Corp

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Holly Magister, CPA

Holly is the founder of Enterprise Transitions, LP where she helps business owners who want to grow their business, plan for its ownership transfer to family members, key employees or to an outside party, or who needs help when it’s time to sell.
Holly founded ExitPromise.com as well as StartupPromise.com and so far has answered more than 3,000 questions asked by business owners about starting, growing and selling a business.

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Your business’s corporate structure will significantly impact a number of issues – including exposure to liability, financing and growth, the number of shareholders, the rate and manner in which you and your business are taxed, and general business operations.  The LLC vs S Corp comparison can be confusing to many.  We want to simplify it for you.

Limited Liability Company’s (LLCs) and S corporations are popular corporate structures thanks to their benefits of liability protection and pass-through taxation. Here, we’ll break down the drawbacks and benefits of each structure in an effort to help you make the right choice for your business.

Single Member LLCs

Limited Liability Company Ownership

A Single member LLC functions similarly to a sole proprietorship in that the member maintains complete control over business operations. The single member does not have to deal with any shareholders or a board of directors, the way a corporation is required to do. The member may make all business decisions, and in turn, is entitled to the full share of distributed profits.

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Limited Liability Company Personal Liability

One of the most appealing benefits of an LLC is that the member is not held personally liable for most of the debts of the business. Certain debts, such as unpaid payroll tax withholdings, never escape personal liability exposure for the business owner. That said, if the LLC is sued, goes bankrupt, or otherwise can not pay its debts, the member’s personal assets and property are generally not at risk. It is important to note that some states do not allow single member LLCs – meaning that multiple owners are a requirement to form an Limited Liability Company.

Limited Liability Company Taxes

Single member LLCs also often enjoy pass-through taxation, allowing the business to pay taxes like a sole-proprietorship. This means that instead of the business entity itself paying taxes, the profits are passed directly through to the member, who reports the income on their personal tax return. A single member LLC does not pay business tax at the federal level. And in most states there is also no business tax for single member LLCs.

Multi Member LLCs

A multi member LLC functions the same as a single member LLC, with the exception to ownership. Instead of a single owner, there are multiple owners who share business decision-making responsibilities. A multi member LLC will still enjoy pass-through taxation, with each member paying a portion of the LLC’s taxes on his or her personal income tax return. The amount of taxes each person pays is usually proportionate to the amount of ownership they have in the business. For example, a member who has a 30% stake in the business would be responsible for 30% of the taxes.

Limited Liability Company Requirements

While LLC filing requirements allows for significantly more freedom than filing for a corporation, there are some basics that are required.

Business name – The must be unique and not confusingly similar to another registered business. Additionally, the name must include the term ‘LLC’ or Limited Liability Company’ and usually cannot contain ‘Inc.’ or ‘Incorporated.’

Registered Agent – Some states require that a registered agent be appointed as a point of contact for all official documents. The agent usually needs to be a physical resident of the filing state, but does not need to be an owner or employee of the LLC.

Operating Agreement – These are not actually required by the state, but nonetheless, having one is highly recommended. This protects the LLC and outlines how the business will function, including management structure, investment of capital, division of profits, and what happens when a member leaves or passes away.

Articles of Organization – Completing this is the first step to the LLC application.

Business Licenses and Permits – Depending on the type of business you are forming, you will need a number of licenses and permits. These may include: a general business license, tax registrations, zoning or land-use permits, health permits, liquor license, or other state-issued occupational licenses.

Statement of Information Form – Some states require a Statement of Information form to be filed along with your Articles of Organization. This form states your company’s name, its members, and its business address.

Public or Legal Journal Notification — Some states require the newly-formed LLC to post a public notice or legal journal advertisement notifying others of its formation.

Is an LLC Considered a Corporation?

An LLC has certain characteristics of both a corporation and a sole proprietorship or partnership, however it is not a corporation. Instead, an LLC is a type of unincorporated association.

S Corp Requirements

To file your business as an S Corp, you must meet the following requirements:

• Be a domestic corporation.
• Have only allowable shareholders (individuals, certain trusts, and certain estates – but not partnerships, corporations, or non-residents).
• Have no more than 100 stockholders, all of whom consent to S corporation election.
• Have only one class of stock.

S Corporation Formation Requirements

Filling for an S Corp requires several steps:

1. Shareholder(s) – Each corporation must have at least one shareholder – these are the owners. One of the shareholders forms the corporation, or alternatively, a registered agent may do so on behalf of the shareholder(s).
2. Articles of Incorporation – Sometimes called the certificate of incorporation, business owners are required to first file as a corporation. This form must be filed with the state and all necessary filing fees paid.
3. Federal Form 2553 – All shareholders must sign and file this form once the business is incorporated if they desire to form the S Corporation.
4. Federal Tax ID – This is required for all Corporations.
5. Business Licenses and permits – Once your business is registered, business owners need to file for the necessary licenses and permits. These vary by industry, city, and locality. Just like an LLC, these can include a general business license, land-use permits, health permits, and more.
6. First Meeting of the Board of Directors — to be held to authorize the formation of the business and other important matters to establish the business.
7. Public or Legal Journal Notification — Similar to the LLC, some states require the newly-formed Corporation to post a public notice or legal journal advertisement notifying others of its formation.

Corp Shareholder Distribution Rules

Similar to an LLC, S corporations enjoy pass-through taxation. As a pass-through entity, S corporations distribute their net profit or net earnings via the payment of dividends to shareholders. These dividends are only taxed at the shareholder level.

S Corporation Shareholders, who are active in the business, must be paid a reasonable amount of compensation via a payroll check. Unlike S Corp distributions paid to shareholders, compensation is taxable at the federal level, is subject to FICA and Medicare taxes, and in most states, also subject to state and local income taxes.

S Corporation Distributions paid to shareholders must be paid equally and in proportion to the shareholder’s relative ownership percentage.

LLC vs S Corp Chart

Don’t let the LLC vs S Corp decision slow down your startup!