S-corp vs. LLC: Differences + pros and cons

Choosing the right business structure, Limited Liability Company (LLC) or S-corp, can impact your taxes, liability, and how you grow. When you first start a business, you may not think about what type of business structure you need. That usually means, by default, you become a sole proprietor. 

However, a sole proprietorship isn’t a formal business entity. And because you and your business are essentially one, there’s no legal separation between the two. One option is to choose a business structure that will separate you from your business to protect your personal assets. 

Suitable business structures to consider are an S corporation and an LLC. This guide breaks down the differences to help you decide which is best for your business. 

Jump to:

• What is an S Corporation?
• What is an LLC?
• Differences between S-corps and LLCs
• Similarities between S-corps and LLCs
• Pros and cons of S-corps vs. LLCs
• Run your business with confidence

What is an S corporation?

An S corporation, or S-corp, is a business structure that offers limited liability protection to owners and shareholders and certain tax benefits. You must meet some requirements to qualify for it, including having 100 or fewer shareholders and operating in the US.

S-corps are attractive because they offer several benefits that set them apart from other types of business structures:

• Pass-through taxation: Profits and losses pass through to the owner's personal tax return, avoiding double taxation
• Limited liability protection: Owners’ personal assets are protected from business debts and legal actions
• Potential tax savings: S-corp owners may reduce self-employment tax by paying themselves a reasonable salary and taking the rest as distributions
• Credibility with investors: The formal structure can enhance your business's professional image

Together, these benefits make the S-corp a popular option for growing businesses that want liability protection and tax efficiency.

What is an LLC?

A Limited Liability Company, or LLC, is a type of business structure that combines the limited liability protection of a corporation with the flexibility and simplicity of sole proprietorship or partnership.

Forming an LLC establishes your business as a separate legal entity from yourself as an owner, so you are not responsible for the business's debts and liabilities. 

There aren’t many ownership restrictions for LLCs, making them a more flexible option for business owners, who can choose to be taxed either as a corporation or a pass-through entity. 

Differences between S-corps and LLCs

There are some differences between S-corps and LLCs, including ownership restrictions, taxation, and management. Here are some of the main differences:

Ownership restrictions

S-corps and LLCs differ significantly when it comes to who can own them. S corporations have more rules, while LLCs offer greater flexibility.

S-corp ownership rules:

• Limited to 100 shareholders
• Shareholders must be individuals (not other companies)
• Must be US citizens or certain types of trusts or estates

These restrictions can make it harder to raise funds from a wide pool of investors.

LLC ownership rules:

• No limit on the number of members
• Members can include individuals, other LLCs, corporations, or foreign entities
• No US citizenship requirement

This flexibility gives LLCs more options when it comes to ownership structure and raising capital.

Taxation

S-corps and LLCs also differ in terms of taxation. S corporations are pass-through entities, which means the business itself doesn’t pay federal income tax. Instead, individual shareholders report income, deductions, and credits through their personal tax returns.

An LLC is also a pass-through entity by default. However, it can choose how it is taxed and can elect to be taxed as a corporation if it’s more advantageous for its members. 

Management

Another big difference between the two is management and formalities. S corporations usually have a more formal management structure, which means they’ll have a board of directors elected by the shareholders, overseeing major decisions, and officers managing day-to-day operations. 

S-corps also have to hold regular shareholder meetings, keep minutes of meetings, and maintain proper financial records. LLCs have more flexibility in terms of management and formalities. They can be member- or manager-managed:

• Member-managed: All members participate in decision-making. 
• Manager-managed: Members appoint managers to run the business

LLCs also usually have fewer formalities than S corporations and are only required to have an operating agreement, signed by each member, and an annual report. But it’s still recommended to outline responsibilities and rights and keep track of records.