A limited liability company (LLC) is a type of business entity formed as a private company in the United States. An S corporation (or S corp) is a corporation that elects to be taxed as a pass-through entity (the business does not pay income tax at the entity level; the owners do). While they are different, they have some similarities. Both protect the owners from being used to pay the company’s debts, and both are useful for businesses that are growing but not ready for a public stock offering.
An LLC is a simpler, more flexible, and less expensive option than a corporation. The S corp requires a board and a lot more documentation. The S corp can be costly to create and to keep operating. Deciding which option is better for your business depends on the needs of your business.
What Is an LLC?
An LLC is a type of business structure. It allows the liability protection and pass-through taxation of a corporation with the simplicity of a sole proprietorship in everyday operations. Small and medium businesses often use this form of business.
Pros of an LLC
- Personal liability protection
- Less regulated than a corporation
- Pass-through taxation
- Great flexibility
- Lower costs compared with an S Corp
- Can issue membership interests or membership units that are akin to stock
There can be one or more members, or owners, in an LLC. The company can organize the business structure as they choose. Don’t want a board of directors? No problem. Want to share profits among partners? You can do that. An LLC having a choice in whether it has directors or members creates great flexibility.
Cons of an LLC
- Difficult to attract investment or venture capital
- LLC rules vary by state
What Is an S Corporation?
S corp is a tax classification used by corporations that choose to pass corporate income, losses, deductions, and credits for federal taxes through to their shareholders. This type of corporation, with a board and managers, can have up to 100 shareholders. It cannot have foreign shareholders, and the shareholders must be individuals, not other corporations.
To become an S corp, business owners must file Form 2553, Election by a Small Business Corporation with the Internal Revenue Service (IRS). They will pay yearly fees in addition to the initial cost. After that, there are paperwork requirements to keep up with. But all these requirements make the corporation more attractive to outside investors. Anyone growing a small or medium-sized business often chooses the S corp designation.
Pros of an S Corporation
- Personal liability protection that is stronger than an LLC
- More attractive to investors
- Strong documentation rules which will help protect your business
- Clear management structure
Cons of an S Corporation
- Must file and keep lots of documents
- Limited to 100 stockholders
- Significant costs at start-up and then annually
- Owners must be U.S. citizens
When an LLC Is Better
A partnership is the simple structure option for two or more people owning a business together. As a business grows, you may not want to have personal liability for fines against the company. An LLC offers some liability protection while keeping the amount of paperwork and related costs lower than an S corp.
If you have an international partner or partner who is not a U.S. citizen or green card holder, your business cannot be structured as an S corp:Members of an S corp have to be U.S. citizens. LLCs also can have an unlimited number of members—an S corp is limited to 100 shareholders—and they can be corporations and partnerships, not just individuals.
If you want owners to be part of management, an LLC offers the option of designating certain members as managers. If your business has a medium risk of being sued, the LLC protects personal assets.
When an S Corporation Is Better
If you want to minimize taxes, the S corp could be a good choice because it has pass-through taxation; you receive your earnings for running the company as wages. You can also select a different person to run the company and just become a member-owner. The S corp offers stronger personal liability protection than an LLC.
If you want to sell stock and become publicly traded, an S corp is a better option. For LLC to sell shares publicly it would need to become a corporation such as an S corp. This oversight ensures investors that your company is a solid investment. Investors prefer S corporations because they can trade their investment for partial ownership of the company.
Can a Business Be Both an LLC and an S Corp?
You may be interested in making your business both an LLC and an S corp. Selecting both can give you the best features of each. Owners can become employees and simplify their taxes while making payments into Social Security and Medicare. They can also get profits as shareholders.
The question to answer is: Does either or do both provide the tools you need to start and scale your business? The forms are similar in granting pass-through taxation and limited personal liability. The LLC is simpler, more flexible, and costs less. The S corp allows stock sales, a clear management structure, and an increased ability to raise funds.
To learn more, sign up for Columbia Law School’s A Legal Toolkit for Starting and Scaling Your Business, a non-credit certificate program designed for business owners and others who want to know more about the legal aspects of business and entrepreneurship.