A business structure refers to a business that significantly impacts some essential issues or activities conducted by you to earn loads of profits in terms of a legal entity.
Some of these issues are the exposure to liability, the management structure of your business, the rate and the manner you and your business are liable for paying tax, etc.
We all want to have a business structure that suits our skills and the liability availing capacity, and then two names pop up in your mind: LLC and S Corporation.
So we are back with this article where we will tell you what is an LLC and S Corporation with their pros and cons.
And what is the difference between the two of them so that you can find out the type of business that is best for you?
What Is an LLC?
A Limited Liability Company or an LLC defines a business structure that is becoming popular in small business owners who want to keep their business structure formal and have limited liability.
An LLC supports the business owner in limiting their liability for business obligations. It has one of the most flexible ways of running a business and distributing the members’ profits.
In some states, LLCs have less strict rules for record-keeping as compared to corporations. Plus, they are also flexible in their taxation.
An LLC tax is like a sole proprietorship or partnership. If you are the owner or member of an LLC who also works in the business, the IRS will consider you a self-employed person.
You can file an LLC tax return of your return on schedule, and you can also pay self-employment and income taxes of your share coming from the company’s profit.
- The owner or member of a single person LLC doesn’t have to file a tax return for their LLC business. He is only responsible for reporting the activities regarding his personal tax return.
- Most of the forms for LLC formation are single-page only for single-member LLCs. So don’t have to put your whole day in filling that form.
- The cost of incorporating an LLC is also very affordable as it requires only a couple of hundred dollars, and the business is ready to run.
- The Red tape involved in forming an LLC isn’t that strict as it is in S Corporation. You can save your money by hiring an accountant or attorney.
- Single-member LLC owners are liable to pay self-employment tax on their income earned from their LLC business, which means paying quarterly estimates to the IRS.
What is an S-corp?
An S Corporation or S-Corp or S subchapter, the tax collection enables the IRS to know that your business needs to be taxed just like a partnership firm. Forming an S-corp also helps your business in avoiding corporate-level double taxation.
To convert your business into an S-Corp, you must first register like an LLC or a C Corporation.
In an S Corporation, the owners of the business are shareholders. As the owner, you have to consider yourself an employee of the business and pay yourself a salary.
All the profits, losses, credits, and deductions are taxed only at the shareholder level.
To qualify to start an S-Corporation, it must have 1 to 100 shareholders, and it must be in the US. Also, you have to file it with the IRS as an American corporation.
S Corp Pros:
- An S Corporation’s significant advantage is that it offers you tax benefits when it’s about excess profits, known as distribution.
The corporation also pays a reasonable salary to its employees, which directly reflects that this must tie with industry norms by detecting payroll expenses like FICA and Federal taxes.
Then, remaining profits get distributed between the owners in terms of dividend which is taxable at a lower rate.
S Corp Cons:
- It costs more for the formation of an S Corporation as compared to the LLC.
- Shareholders must always cohere to the requirements. If they don’t do so, they risk disallowing the S corp election. Then, the corporation will get treated as a C Corporation with all the corresponding restrictions.
- Owners can’t have more than 25 percent of gross receipts for doing passive activities.
- S Corporation has to pay some additional State taxes if charged.
The Similarities of LLCs and S Corps
LLCs and S corps have some similarities, and they are:
1. Limited liability protection:
The owners/members of LLCs and Corporation are not personally held responsible for business liabilities and debts.
Instead of this, the LLC or the S corp, being the business owner, is accountable for its debts and liabilities.
2. Separate entities
Both the LLC and S Corporation have separate legal entities formed by a state filing. Though, they are formed and governed by different state business entity statutes.
3. Pass-through taxation
Both are pass-through tax entities. With pass-through taxation, there is no need to pay income taxes at the business level.
Profit or loss of business is passed-through to owners’ tax returns. And any necessary tax is reported and payable at the individual level only.
4. Ongoing state compliance requirements:
Both the business entities are subject to some m obligations imposed by the LLC Statutes and state corporation, for instance, appointing and maintaining a registered agent, payment of annual fees, filing annual reports, notifying the state of specific changes such as a change of name.
LLC Vs. S-Corporation: Key Differences
Small business owners often go for an LLC as it offers more freedom to the members than corporation types.
But before you make any decision, let us discuss some key differences between the LLC and S-corp.
An S-corp doesn’t fall into business entities like a sole proprietorship, partnership, LLC, or a corporation. Instead, it is an elected method of identifying the way you want your business to be taxed.
With an S corp status, your business can avoid double taxation, which happens when a corporation gets taxed on the profits. A tax then gets charged when the dividend gets distributed among the shareholders as their personal earnings.
An LLC can be a C Corp and S corp; it depends on how the business owner wanted their business to be taxed. S Corp is a matter of federal tax law, and the other hand and an LLC is the subject of State law.
In the case of LC members or owners have to pay self-employment taxes directly to the IRS. All income generated by an LLC is considered taxable income.
And in S Corp, the business has to pay its payroll taxes, and shareholders get a deductible salary from the company’s taxable income in the form of business expenses.
And if the business has some profit left in its account, it has to be distributed between the shareholders.
Both LLC and S Corps have different management structures.
“When members manage an LLC, it is more like a partnership or a sole proprietorship if there’s only one member,” stated Guy Baker, Ph.D., Founder of Wealth Team Alliance.
“If run by managers, LLCs more closely resembles a corporation, as members will not be involved in the daily business decisions.”
He also mentioned that S-corp has officers and directors and a board of directors who manages major decisions and Corporate formalities.
An LLC can have unlimited members, whereas S – Corps can’t exceed the limit of shareholders more than 100 in total. Besides, An LLC can allow citizens outside the US to become members of their organization, but An S-Corps can’t do the same.
Both the organizations have entirely different subsidiary restrictions. Where LLC can permit their subsidiaries without restrictions, and S-Corps are not allowed to set any subsidiaries.
At last, S-Corps can issue stocks for only one class, but LLCs can’t.
How to File as an S Corporation
In case your business qualifies for setting it as an S-Corp, it is a straightforward process. Now, all you should do is file your form with the IRS to get elected as an S Corporation.
If you choose the right tax system, then it can save loads of money for your company.
For that, you have to consider the profitability of your company, potential taxes, and your growth and retirement plans. You can seek help from a Lawyer.
The Last Words
For most businesses, it makes sense to register for S-corporation if you want to save on taxes.
As discussed above, we’ve found various similarities between LLCs and S-corps, like limited liability, pass-through taxation, and separate entities.
Further, there are more formalities with S-corps, adopting bylaws, holding initials, issuing stock, meeting annual directors and shareholders, and keeping minutes of meetings.
So this is all for this article. I’ve tried to sum up all the information you need to know regarding the difference between LLC and S-Corporation.