S-corp vs. LLC: What’s the difference?

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. You don’t need to file paperwork to become one, and many small-business owners find this works for them.

But there are drawbacks: 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 limited liability company (LLC).

This S-corp vs. LLC guide compares the differences and similarities between the types of business structures and their pros and cons.  

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..  

The protection of personal assets is a benefit that attracts many business owners to the S corporation, but this structure also provides other perks, especially compared to other types of corporations. 

That’s because, S corporations aren’t taxed twice, like C corporation owners, instead taxes pass through to the business owner’s personal income tax. This means you file taxes once for both yourself and your business.  

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 they are not responsible for the debts and liabilities of the business. 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 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

The first difference between S-corps and LLCs is their ownership restrictions. That’s because S corporations have stricter eligibility criteria than LLCs. 

If you want to form a S-corp, you’ll have limitations on the number and type of shareholders. S-corps can’t have more than 100 shareholders, and they must be individuals, generally US citizens or certain trusts or estates. For many businesses, that’s plenty, but it can limit your ability to raise capital in the future.

Limited liability companies are more flexible when it comes to ownership. They can have an unlimited number of members, which can include individuals, other LLCs, corporations, and even foreign entities. These members aren't required to be U.S. citizens, which can open up your ability to raise money from more sources.

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 income. 

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

Similarities between S-corps and LLCs

Although LLCs and S corporations have some differences, they also have similarities—especially when compared to other business structures. Here are some similarities between the two:

Limited liability protection

The first thing both S-corps and LLCs have in common is one of their biggest benefits: Limited liability protection. 

This means S-corp shareholders and LLC members have liability protection, their personal assets are protected, and they are generally not responsible for the business’s debts and liabilities. When shareholders and members have limited liability protection, their personal assets are off-limits if a company loses money, so they’ll lose only the amount they invested. 

Pass-through taxation

Both S corporations and LLCs benefit from pass-through taxation—although LLCs could opt to be taxed as a corporation. 

This means the business itself doesn’t pay federal income tax. Instead, income, deductions, and credits pass through to ‌individual members and shareholders, who report this income on their personal tax returns. 

The main benefit of pass-through taxation is avoiding double taxation. The business’s earnings are only taxed once when the shareholder or member claims it on their tax return. Pass-through businesses may also claim the qualified business income deduction. 

Flexibility

Lastly, another similarity between S-corps and LLCs is their flexibility. Although S corporations have some restrictions on the number of shareholders, they can still have multiple individual shareholders. LLCs have even more flexibility in terms of ownership, as they can have an unlimited number of members. 

Both S-corps and LLCs are regulated at a state level and can have management flexibility. S-corps elect a board of directors, and LLCs can choose between member management or manager management.

Pros and cons of S-corps vs. LLCs

Picking the right business structure will depend on your needs and goals. Understanding the pros and cons of S-corps and LLCs can give you a better idea of which one’s better for your business. 

Some of the pros and cons of S-corps include:

Some benefits of having an S-corp include avoiding various self-employment taxes, being taxed as pass-through entities and limited liability protection. However, they have more formalities, such as holding regular meetings and maintaining records, and a limit on the number of shareholders. 

Some pros and cons of LLCs include:

Similarly to S-corps, LLCs also have the benefit of limited liability protection and pass-through taxation, with the bonus of more management flexibility. However, LLCs are subject to self-employment taxes and may have a limited life span depending on the state. 

Run your business with confidence

If you plan to seek funding from investors, being positioned as an S corporation or an LLC can help. Many investors won’t fund a business that doesn’t operate under a formal business structure. 

Knowing the difference between an S-corp vs. LLC can help you decide which business structure works best for you and bring you benefits that align with your goals. Having a formal business structure is one of the first steps to building a successful business. Get your business’s finances and taxes organized with accounting software like QuickBooks, which lets you focus on running your business confidently.