S Corp vs LLC - Difference Between LLC and S Corp | TRUiC (2024)

LLC vs. S Corp

Before we explore the main differences between LLCs and S corps, it's essential that you understand what each of these actually are.

What Is an LLC?

An LLC, or limited liability company, is a business structure that combines the personal liability protection of a corporation with the tax flexibility of a sole proprietorship or general partnership.

If you're a startup or small business owner who is looking for simplicity, flexibility, and low cost, an LLC can offer an easy-to-manage option that shields your personal assets from most potential business debts.

For more information, we recommend having a look at our What is an LLC article.

What Is an S Corp?

An S corp – which stands for “Subchapter S Corporation” in the Internal Revenue Code – isn't a separate business entity type. Instead, it’s a special tax election which you can select as either an LLC or a C corporation.

S corp status allows owners to classify a portion of their income as dividends, which are subject to neither self-employment nor FICA taxes. This can make S corps ideal for businesses that surpass a certain annual revenue threshold.

See our What is an S Corporation article for a more in-depth look at the requirements and specifications of an S corp.

What’s the Difference Between an S Corp and an LLC?

There are several important differences between an LLC and a business structure that has elected S corp status. We’ve broken down the most important ones below.

S Corp Taxes vs. LLC Taxes

In an LLC, all earnings and losses are passed directly to individual members, who are then required to report income on their personal tax returns. This arrangement is known as "pass-through taxation.”

LLCs are not subject to corporation taxes, but all the income that’s generated is funneled directly to the applicable owners, who then pay self-employment taxes.

In contrast, an S corp permits you to categorize part of your income as dividends or distributions. While the business still avoids corporate income taxes (similar to an LLC), the significant advantage is that income earmarked as dividends is exempt from both self-employment and payroll taxes. This setup can yield considerable tax savings for business owners.

Having said that, it's essential to note that S corp shareholders are considered employees and must pay themselves "reasonable compensation" or a “reasonable salary.” This salary needs to be in line with current market rates and is subject to FICA taxes.

This means that — depending on your expected annual revenue — it might not make financial sense for you to elect to be taxed as an S corp.

Example:

Imagine you own a small digital marketing agency with an annual revenue of $70,000. After paying yourself a reasonable salary in line with industry standards (let's assume $65,000), there would only be $5,000 left to take as dividends exempt from self-employment and payroll taxes. In this scenario, the extra paperwork and regulatory requirements of maintaining an S corp might not be worth the relatively minimal tax benefit that you'd gain.

Fees and Paperwork

LLCs are generally easier and less costly to start and operate. The paperwork is more straightforward, and the annual requirements are less complex, making it a popular choice for small businesses.

S corps, on the other hand, require meticulous recordkeeping, adherence to strict corporate governance procedures, and compliance with additional regulations. This often means more paperwork and, in some cases, higher administrative costs.

Profit Distribution

LLCs provide greater freedom in the distribution of profits and losses among members. This is because LLC owners retain complete autonomy when it comes to how profits and revenue can be distributed (e.g., through an operating agreement, etc.).

On the other hand, owners of S corporations have significantly less flexibility and can actually be at a disadvantage when they're looking to re-invest a significant amount of revenue back into their business.

This is because all owners are required to receive “reasonable compensation,” which can significantly limit how much revenue is left for reinvestment.

All in all, choosing between an LLC and an S corp is not a one-size-fits-all decision. The tax benefits of an S corp, such as saving on self-employment and FICA taxes, become increasingly advantageous as your income grows. However, these come at the cost of additional operational complexities and administrative fees.

Given the differences in tax treatment, administrative burdens, and operational flexibility, your choice should hinge on your specific needs. We recommend considering your projected income, willingness to handle paperwork, and preferred management structure as crucial variables in your decision.

Is an S Corp Right for Me?

Deciding whether to elect S corp status for your LLC will largely depend on your business's financial projections, as well as on your plans for profit distribution.

As a general rule of thumb, if you anticipate your annual company profits to exceed $10,000 after drawing a reasonable salary, electing S corp status could offer substantial tax benefits that justify the drawbacks.

However, if you're still uncertain about your business's profitability or plan on reinvesting most of your profits back into the company, maintaining your default LLC tax classification with the IRS might be your best course of action.

Many LLC owners opt for this path because it allows for greater operational and financial flexibility. This is particularly beneficial for small businesses that commonly reinvest profits into growth initiatives, such as marketing and equipment upgrades.

So, if you intend to channel most of your profits back into your business for growth, or if you prefer the option to not pay yourself a salary, the default LLC classification provides more flexibility and is likely the better choice for you.