LLCs Versus S corporations

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When entrepreneurs consider how to incorporate when starting a business, or when existing small business owners consider changing their business structure, they are often evaluating between the limited liability company (LLC) and the S corporation as the entity type for their business.

As your learn how to incorporate, you will see LLCs and S corporations have some similarities, most notably limited liability protection for owners and pass-through taxation, they also have a number of distinct differences. If you are one of the business owners trying to form a corporation, this article will help you compare LLCs and S corporations a little more closely.

Similarities

1. Both offer the same limited liability protection for owners, meaning that the owners are typically not personally responsible for the debts and liabilities of the business.
2. Both are separate legal entities created by a state filing. 
3. Both are typically pass-through tax entities. While both entities file business tax returns, the profit or loss of the business is passed-through to the owners’ personal tax returns, where it is reported and any necessary tax paid at the individual level. 
4. Both are subject to external formalities, such as filing annual reports, which are required by the state, and paying necessary annual fees.

The Differences

1. Ownership

• The Internal Revenue Service (IRS) restricts ownership of S corporations, while LLCs do not face the same restrictions. Some of the IRS restrictions include:
• LLCs can have an unlimited number of members (owners) while S corporations can have no more than 100 shareholders (owners).
• Non-US residents can be members of LLCs, while S corporations may not have non-US residents as shareholders.
• S corporations cannot be owned by C corporations, other S corporations, LLCs, partnerships, or many trusts. LLCs are not subject to these same restrictions.

2. LLCs are allowed to have subsidiaries without restriction.

3. Ongoing Formalities

• S corporations face more extensive internal formalities, including adopting bylaws, issuing stock, holding initial and then annual meetings of directors and shareholders, and keeping the minutes of these meetings with the corporate records.
• While LLCs are not subject to the same internal formalities, they are encouraged to adopt an operating agreement, issue membership shares, hold and document annual meetings of the managers and/or members, and properly document all major decisions of the company. 

4. Management

• The management of an LLC can be by members, in which case the management is much like that of a partnership. If the management of an LLC is by managers, then the management structure more closely resembles that of a corporation, since the members will not be involved in the daily business decisions of the company.
• S corporations have directors and officers. The board of directors oversees and directs the affairs of the corporation and has responsibility for major decisions, but is not responsible for the day-to-day operations of the corporation. The directors elect officers to manage the daily affairs of the business.

5. An S corporation’s existence is perpetual. Conversely, an LLC typically has a limited life span. Most states require that LLCs list a dissolution date in the formation documents (typically called the articles of organization or a certificate of organization), and certain events, such as death or withdrawal of a member, can cause the LLC to dissolve.

6. The stock of an S corporation is freely transferable, as long as IRS ownership restrictions are met. The membership interest (ownership) of an LLC typically is not. Approval of the other members must be received.

7. An S corporation may have advantages with self-employment taxes in comparison to the LLC. For more information on this issue, please contact your accountant or tax advisor.

As you determine which business structure is the best option for you to form a corporation, there are both online and professional resources to assist you. BizFilings’ Incorporation Assistant can help you compare different entities based on a number of considerations that are important to you. For advice on which structure to choose, you should contact an attorney or accountant.

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