What is the Difference Between an LLC and an S Corp? (2024)

If you’re just starting out on your entrepreneurial journey, or if you’re thinking about changing your business’ current structure, you might be asking yourself: “What is the difference between an LLC and an S corp?”. These are two of the most popular business structures and while they do share some similarities, there are some major differences between how they operate.

To help you decide which of the two would be more suitable for your business, we’ll go over the advantages and disadvantages of LLCs and S corps and provide an overview of their similarities and differences.. At the end of our article, you’ll find a detailed FAQ section that goes over some of the most pressing questions related to the differences between these two structures.

Without further ado, let’s start by defining what an LLC is.

Sections

What Is an LLC?

An LLC stands for Limited Liability Company and it’s a type of business structure that grants liability protection to its members. Essentially, it’s a type of company that protects its members/owners from being personally liable in case the company undergoes legal troubles in the form of a lawsuit, claim, or debt.

There are multiple different types of LLCs that differ in terms of where they’re formed and how many members they have.

Single-member LLCs
Multi-member LLCs
Domestic LLCs
Foreign LLCs
Anonymous LLCs
Series LLCs

Advantages of Forming an LLC

If you can’t decide between forming an LLC or an S corp, it’s useful to consider the benefits and drawbacks of each type of business structure to decide what would work best for your needs and resources. Here are some of the most compelling advantages of forming an LLC.

LLCs Provide Limited Liability

As we mentioned earlier, one of the biggest selling points of LLCs is that they provide limited liability for their members. They make for a great option if you want to err on the side of caution and you don’t want your personal assets to be at stake.

LLCs Don’t Require a Lot of Paperwork

Another major advantage business owners love regarding LLCs is that they require less paperwork than corporations. For instance, corporations require more substantial recordkeeping compared to LLCs, which can be quite time-consuming. With LLCs, you only have a handful of requirements you need to keep track of, most of which are related to taxation.

Flexible Management

An LLC can be managed by individuals and other business entities, either by its members or more experienced professional managers. There is a lot of flexibility when it comes to managing LLCs, which is why it’s appealing to so many entrepreneurs.

Moreover, there are no limits as to how many owners and members an LLC can have, giving you a lot of freedom to set up the company according to your desires.

Tax Advantages

Another compelling reason many go for LLCs is the tax advantages that come with forming this type of corporation. LLCs qualify for pass-through taxation, meaning the LLC itself doesn’t pay any corporate taxes, rather the tax expenses are passed through to the owners’ personal tax return. In other words, any profits made in the company are taxed on the owners’ personal tax returns.

Easy to Start and Operate

LLCs are inherently more complex structures than sole proprietorships and partnerships. At the same time, they are much easier to form and operate than corporations, which is something to keep in mind when deciding whether you want to go for a corporation or an LLC.

Disadvantages of Forming an LLC

To give you a balanced overview of both business structures, we’re going to explore some of the disadvantages of forming an LLC that you should ideally keep in mind.

LLCs Have a Shorter Lifespan

As opposed to corporations, LLCs typically have a shorter lifespan. This occurs because LLCs are more vulnerable to being dissolved due to member turnover or bankruptcy. It’s an important factor to keep in mind when you’re thinking about the future of your business.

Harder Ownership Transfer

Pertaining to our previous point, LLCs owners have a harder time transferring the ownership than corporation owners. This is the case because corporations operate with stock, so in case the ownership needs to be transferred, the shares can be sold by the corporation to another owner. With LLCs, there is no such option. The members have to form an agreement whenever a new member gets included or when it’s time to make important decisions regarding the future of the business.

LLCs Can Be Costly

Compared to some business structures like partnerships and sole proprietorships, forming an LLC can be quite costly. They come with higher annual fees, and since they’re inherently harder to operate, they might require hiring legal consultants at various points in the business journey.

Additionally, some states charge extra fees for operating an LLC, so be wary of the fees in your state.

LLCs Are Subject to Self-Employment Taxes

We already listed pass-through taxation as one of the main benefits of forming an LLC. However, you should know that LLCs are also subject to various self-employment taxes. And if your LLC is taxed as an S corporation, you’ll also have to pay additional taxes, like Medicare taxes.

What Is an S Corporation?

An S corporation is a type of corporation that’s allowed to pass its income, credits, and losses directly to its shareholders. S corporations get their name from Subchapter S of the Internal Revenue Code, under which they undergo taxation. It’s a common business structure for smaller businesses that don’t want to invest in operating a complex corporation. The shareholders of an S corp can be individuals, estates, or organizations.

There are some standards your business has to meet to qualify as an S corp, such as being domestic, having no more than 100 shareholders, and having only one class of stock.

Advantages of Forming an S Corporation

Needless to say, this popular business structure is not short of many benefits. Here are some of the advantages you can enjoy if you decide to form an S corp.

Limited Liability

Just like LLCs, S corps also provide limited liability protection for the owners. All the owners’ personal assets are guarded against any potential claim caused by a creditor or a judge.

Pass-Through Taxation

Just like LLCs, S corps qualify for pass-through taxation. The owners and shareholders of an S corp don’t pay taxes on a corporate level, so they enjoy many tax benefits. Instead, the taxation is passed through on their personal income tax returns.

Easy Ownership Transfer

Unlike LLCs, S corps have an incredibly easy ownership transfer. Shares can be divided among members without any impact on taxation or lengthy procedures.

However, the ownership transfer procedures do vary from state to state, so we recommend consulting someone if this is a concern.

Long Lifespan

To add to our previous point, S corps also have a longer lifespan than LLCs. This is because the S corp can continue to exist as long as it’s up to date with all the paperwork and filings. In case an owner dies or can no longer contribute to the management, nothing will change on a structural level.

S Corps Are Seen as Credible

Not all business structures are ranked equal in terms of how credible they’re seen by potential investors and customers. Partnerships and sole proprietorships are not incorporated, which is why some regard them as unstable and undedicated. By contrast, incorporated structures like corporations give off the impression of being official and serious about the business, which is always a plus.

Disadvantages of Forming an S Corporation

Let’s take a look at some potential disadvantages of S corps that might affect your business.

Harder to Set Up and Operate

Unfortunately, there are stricter requirements you have to meet to form an S corp. In addition, S corps come with more rules and regulations you need to follow, so they’re inherently harder to operate.

Not to mention, the formation process is longer and more tedious.

More Annual Fees

With more extensive paperwork come more annual fees. S corps need to file certain documents annually to operate legally, so keep these costs in mind when you’re considering between forming an LLC and an S corp.

Additionally, in some states, S corps are required to pay certain taxes, like franchise tax.

Less Flexible Management Options

As opposed to LLCs, corporations have less flexible management. This occurs because they have a more fixed management structure that includes a board of directors. Additionally, there are certain ownership restrictions, such as not being able to have more than 100 shareholders. Plus, all the shareholders have to be U.S. citizens or residents. In some cases, this could potentially hinder the growth of the corporation.

What Do LLCs and S Corps Have in Common?

LLCs and S corps are separate business structures, but they do have certain things in common.

Liability protection. As we saw from the previous section, one of the main pros of these business structures is that they offer limited liability protection for their members and owners.

Pass-through taxation. Likewise, they also qualify for pass-through taxation, meaning the owners and members don’t have to pay taxes on both a personal and a corporate level.

Subject to fees and requirements. While S corps might be slightly more expensive to operate, both are subject to various ongoing fees throughout the year. Additionally, they need to comply with various regulations given by the state.

The Biggest Differences Between an LLC and an S Corp

At the same time, they differ in many ways, all of which can help you decide if an LLC or an S corp is right for you.

Ownership and structure. One of the main differences between LLCs and S corps is in ownership and business structure. LLCs don’t have many rules regarding the number of members and where they come from, whereas S corps do. As we mentioned earlier, S corps can only have 100 shareholders/owners and they all have to be U.S. residents or citizens.

Ownership transfer. Another important way in which LLCs and S corps differ is in terms of ownership transfer. S corps operate with stock, which is much easier to divide and transfer when the ownership of a business undergoes structural changes. On the other hand, the LLC member’s ownership in the company isn’t easily transferable.

Profit division. Since S corps operate with stocks, it’s much easier to determine the profits and losses of S corp members based on their percentage of ownership. Contrary to this, LLC members have to refer to their operating agreement and have more flexibility in allocating the profits and losses.

Which Business Structure Should I Go For?

We’ve considered the pros and cons of both business structures and explored their biggest similarities and differences. If you’re still struggling to make a decision, here’s our advice that might help.

If you’re a small business owner who doesn’t have the time and resources to dedicate to operating and forming a more complex business structure, then LLC is probably a good option for you. You’ll still receive some of the main benefits associated with S corps, such as liability protection and double taxation, but with fewer fees and legal requirements.

If you have big plans for your business and you’d like to attract more investors and customers, then you should probably opt for an S corp because they’re perceived as being more credible.

If you don’t want to be limited in terms of how many shareholders your company has and where they come from, your best fit would be an LLC.

Lastly, if you don’t have a big budget to work with when you’re first starting off, it’s better to choose an LLC because they’re both easier to form and maintain.

At the end of the day, you can’t go wrong with whatever business structure you decide to choose because you’re allowed to change it at any point. Therefore, it’s best to listen to your gut and opt for the one that’s more aligned with your current vision for the business.

When Should I Change My LLC to an S Corp?

Many entrepreneurs change the structure of their business along the way. If you’re ready to take on more responsibility and you want to work with a more complex business structure, or you simply want to attract new investors and customers, then you should consider changing your LLC to an S corp.

So, how can you know that it’s the right time to do so? As long as your business generates enough profit to withstand the structural change, then it’s the right time for you to start a new journey with a more complex structure.

FAQs

Is an S Corp an LLC?

No, S corps are an entirely different business structure than LLCs, which has different taxation, management, and ownership.

What Is Better for a Small Business LLC or a Corporation?

Small businesses are compatible with both LLCs and corporations. If you’re having trouble deciding between the two, consider your budget and what kind of management you’d like your business to have. If you don’t want to be limited in terms of members, then opt for a corporation. If you have a smaller budget to work with at the beginning and you want a structure that comes with fewer formation and maintenance fees, then opt for an LLC.

What Is Better for Taxes, an LLC or an S Corp?

Another common question business owners have is which of the two structures has better taxation policies.

Both structures qualify for pass-through taxation, which means that the owners won’t have to pay double taxes on a corporate and personal level. LLCs are subject to self-employment taxes, but S corps come with higher ownership transfer fees. It’s up to you to decide which of the two would be more compatible with your goals and set budget.

Final Thoughts

That brings us to the end of our article detailing the differences between an LLC and an S corp. We hope it provided some clarity in terms of whether an LLC or an S corp would be more compatible with your business.

LLCs and S corps share many similarities, like taxation policies and limited liability. However, they have fundamental differences that you should carefully consider to make the right decision for your business.