LLC vs S Corp: The Difference

The basic difference

LLC. The Internal Revenue Service (IRS) says a limited liability company (LLC) is a business structure allowed by state statute. Each state may use different regulations, and the IRS says to check with your state if you are interested in starting an LLC. Owners of an LLC are called members.

S corp. The IRS says S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. The U.S. Small Business Administration (SBA) describes an S corporation as a special type of corporation, and notes that S corps must file with the IRS to get S corp status — a different process from registering with their state.

How each one starts

LLC. An LLC exists under the law of the state where it is formed. The IRS notes that a few types of businesses generally cannot be LLCs, such as banks and insurance companies.

S corp. To become an S corporation, the corporation must submit Form 2553, Election by a Small Business Corporation, signed by all the shareholders.

The two labels can overlap

The two labels are not an either-or choice for every business. The IRS says, in its answers to frequently asked questions about classifying an LLC, that an LLC may elect to be classified as a corporation, or as an S corporation if the LLC satisfies the S corporation requirements. The LLC uses Form 8832 to elect to be treated as a corporation, and Form 2553 to elect to be an S corporation. An eligible business that files Form 2553 on time to elect S corporation status is treated as also having elected to be classified as a corporation. So a business can be an LLC under state law and, at the same time, be taxed as an S corporation at the federal level.

Who can own each one

LLC. The IRS says most states do not restrict ownership, so members may include individuals, corporations, other LLCs, and foreign entities. There is no maximum number of members. Most states also permit “single-member” LLCs — those having only one owner.

S corp. The IRS lists limits that a corporation must meet to qualify for S corporation status:

• Be a domestic corporation.
• Have only allowable shareholders. Shareholders may be individuals, certain trusts, and estates. Shareholders may not be partnerships, corporations, or non-resident alien shareholders.
• Have no more than 100 shareholders.
• Have only one class of stock.
• Not be an ineligible corporation — for example, certain financial institutions, insurance companies, and domestic international sales corporations.

How each one is taxed on income

LLC. The IRS says that, depending on elections made by the LLC and the number of members, the IRS will treat an LLC as either a corporation, a partnership, or as part of the LLC’s owner’s tax return — a “disregarded entity.” The default rules the IRS states are:

• A domestic LLC with at least two members is classified as a partnership for federal income tax purposes, unless it files Form 8832 and affirmatively elects to be treated as a corporation.
• An LLC with only one member is treated as an entity disregarded as separate from its owner, unless it files Form 8832 and elects to be treated as a corporation.
• For purposes of employment tax and certain excise taxes, an LLC with only one member is still considered a separate entity.

An LLC that does not want to accept its default federal tax classification, or that wishes to change its classification, uses Form 8832, Entity Classification Election. The IRS states that, generally, an election cannot take effect more than 75 days prior to the date the election is filed, nor later than 12 months after the date the election is filed.

The SBA adds that, for an LLC, profits and losses can get passed through to your personal income without facing corporate taxes.

S corp. The IRS says shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. The IRS says this allows S corporations to avoid double taxation on the corporate income. The IRS also states that S corporations are responsible for tax on certain built-in gains and passive income at the entity level.

The SBA states the state side of S corp taxation this way: not all states tax S corps equally, but most recognize them the same way the federal government does and tax the shareholders accordingly. Some states tax S corps on profits above a specified limit, and other states do not recognize the S corp election at all, simply treating the business as a C corp.

Employment tax and self-employment tax — what the sources state

LLC. The SBA states that members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security.

S corp. The IRS filing chart for S corporations lists employment taxes the S corporation may be liable for: Social Security and Medicare taxes and income tax withholding, and federal unemployment (FUTA) tax. The IRS chart for S corporation shareholders lists income tax, reported on Form 1040 or 1040-SR and Schedule E and other forms referenced on the shareholder’s Schedule K-1, and estimated tax, reported on Form 1040-ES.

Liability — what the sources state

LLC. The SBA states that LLCs protect you from personal liability in most instances, and that your personal assets — like your vehicle, house, and savings accounts — won’t be at risk in case your LLC faces bankruptcy or lawsuits.

Corporation, including the S corp type. The SBA describes a corporation as a legal entity that’s separate from its owners, and states that the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts the business incurs. The SBA describes the S corporation as a special type of corporation.

Ongoing rules the sources mention

LLC. The SBA states that LLCs can have a limited life in many states: when a member joins or leaves an LLC, some states may require the LLC to be dissolved and re-formed with new membership — unless there’s already an agreement in place within the LLC for buying, selling, and transferring ownership.

S corp. The SBA states that S corps must still follow the strict filing and operational processes of a C corp. The SBA also states that S corps have an independent life, just like C corps: if a shareholder leaves the company or sells his or her shares, the S corp can continue doing business relatively undisturbed.

The IRS forms named on the source pages

• Form 2553 — the election submitted, signed by all the shareholders, to become an S corporation. The IRS says limited liability companies use this form too, when they elect S corporation status.
• Form 1120-S and Schedule K-1 — the forms in the IRS filing chart for an S corporation’s income tax.
• Form 8832 — the Entity Classification Election an LLC uses to elect how it will be classified for federal tax purposes.