When starting a business, one of the first and most critical decisions is choosing the proper business structure. Two popular options for small and medium-sized businesses are the limited liability company (LLC) and the S corporation (S corp). Each of these business structures has its own set of advantages and disadvantages.
Spoiler Alert: It’s not LLC OR S CORP. It’s AND. S Corp is a tax status with the IRS, so you can be both an LLC and S Corp in the eyes of the IRS.
What Is an LLC?
A limited liability company (LLC) is a flexible business structure that combines the liability protection of a corporation with the simplicity and tax benefits of a partnership. This hybrid business entity is popular among small business owners because it offers many advantages.
Pros of an LLC
Many businesses prefer to structure themselves as LLCs because of these critical benefits:
- Limited Liability Protection: The primary advantage of an LLC is that it offers personal liability protection to its owners, usually called “members.” In the event of legal troubles or debt, the LLC typically shields members’ personal assets from business liabilities.
- Pass-Through Taxation: LLCs are not subject to double taxation, as the members pass their profits and losses through their personal tax returns. This process means that the business itself is not taxed, and members report their share of income on their individual tax returns.
- Flexibility in Management: LLCs are highly adaptable in terms of management. They can be member-managed, where all members have a say in daily operations, or manager-managed, where specific individuals or entities are designated to manage the company.
- Taxation Options: LLCs provide flexibility in terms of taxation. Depending on their tax planning needs, members can choose their tax status as a sole proprietorship, general partnership, or corporation (C corp or S corp).
- Ease of Formation and Maintenance: Setting up an LLC is relatively straightforward, requiring minimal paperwork and formalities. Ongoing compliance requirements are usually less burdensome compared to corporations.
Cons of an LLC
While LLCs offer significant benefits, there are a few scenarios where they are not the best entity. Namely, people raising capital, needing to transfer ownership easily, among others. For the vast majority, the LLC is great, but here are some limitations.
- Limited Stock Options: If you plan to raise capital by selling stock or attracting investors, an LLC may not be the best choice, as it has limited options for selling ownership interests.
- Transfer of Ownership: Transferring ownership or selling the company can be more complicated in an LLC due to the need for unanimous member consent or specific provisions in the operating agreement.
What Is an S Corporation?
An S corporation, often referred to as an S corp, is a particular type of tax status that, when elected, allows for pass-through taxation similar to an LLC. S corps provide limited liability protection and are subject to specific requirements and restrictions set by the Internal Revenue Service (IRS).
Pros of an S Corp
The S corp structure offers several advantages for businesses, including:
- Pass-Through Taxation: Like an LLC, S corps enjoy pass-through taxation, which means the company itself is not taxed, and profits and losses pass through to shareholders’ individual tax returns.
- Added Compensation: S elections can combine salary and profits. This setup allows them to pay self-employment tax only on their salary, potentially reducing tax liability.
Cons of an S Corp
While S corps offer many benefits, they also have some significant drawbacks, such as:
- Strict Ownership Rules: S corps have limitations on ownership. They can have no more than 100 shareholders and specific restrictions on who can be shareholders. Only U.S. citizens or residents are allowed to be owners.
- Ongoing Formalities: S corps have more administrative requirements than LLCs. These include holding regular board meetings, maintaining corporate minutes, and following other formalities to maintain your S corp status.
- Eligibility Restrictions: To qualify as an S corp, your business must meet specific requirements, such as issuing only one class of stock.
Frequently Asked Questions
Do I need an LLC for my business?
An LLC can benefit small business owners, especially if you want to protect your personal assets from business debts and liabilities. Whether you need an LLC for your business depends on various factors, including your business goals, structure, and the level of personal liability protection you desire.
Is an S corp an LLC?
No, an S corporation is not an LLC. An S corporation is a specific tax designation that certain business entities, including LLCs and traditional corporations, can elect. While an S corp enjoys pass-through taxation, it is primarily a tax status and not a legal structure. An LLC, on the other hand, is a distinct legal business structure that offers limited liability protection and allows for flexible taxation options.
Can I be an LLC that files as an S Corp?
YES! This is not an either or decision. YOu can be both because one is an entity and the other is a tax status (albeit can also be an s corp in a corporation structure). There is no one-size-fits-all answer, as both options have advantages and disadvantages. Consult with a legal and financial expert to make an informed choice that aligns with your business objectives.
Should I make my LLC an S Corp?
Making your LLC an S corp can be advantageous for certain businesses. Electing S corp status for your LLC is a decision that depends on your financial goals, tax situation, and the nature of your business.
Can a single-member LLC be an S corp?
Yes, a single-member LLC can choose an S corp status for tax purposes. However, following all legal and tax requirements associated with this choice is crucial. Consult a legal and financial professional for guidance on making this decision for your business.