LLC vs S-Corp

It is common to assume that both LLC and S-corp are business entities. They are not. LLC is a business entity, whereas S-Corp is just tax classification.

There are several more differences between them.

Before we dive in, here's a quick summary table.

LLC

S-corp

Legal entity

Yes

Tax entity

Types

Single-member LLC,
Multi-member LLC

S-corp is a classification

Liability protection

Yes

Default tax treatment

Sole proprietorship for single member, Partnership for multi member

S-corp

Double taxation

Formalities

Relatively less. Easier to maintain

More paperwork due to the hiring requirements

Ownership

Owned by members

Owned by a maximum of 100 individual shareholders

Organisational structure

Members usually govern and execute everything

Shareholders elect board members who govern the corporation. These board members choose officers(including president, vice president, etc) who execute stuff

Definition

What are LLC and S-corp?

Limited Liability Company or LLC, a legal entity formed under state statutes, is like a hybrid between a corporation and a sole proprietorship. It gives business owners protection from personal liability and has pass-through income.

S-Corporation or S-Corp is a tax classification made by companies that allow income & losses to be passed through to the shareholders. The election can be made by any one of the existing business entities: LLC, C-corporation or partnership.

Types

What are the different types of LLC and S-corp?

LLC with a single member(owner) is referred to as a single member LLC, whereas if you have multiple members, it is known as multi-member LLC. Without changing the legal entity, an LLC can also elect to be treated as a C-corporation or S-corporation for tax purposes.

There is only one type of S-corp election. Any eligible business entity can elect to be treated as an S-corp by filing Form 2553.

Ideal for

Who are LLC and S-corp ideal for?

LLC is ideal for small business owners who have been running sole proprietorship and would need liability protection. It is sort of the next stage that business owners move into after starting their business as a sole proprietorship.

S-corp is ideal for small businesses who have started making an income of more than $60k per annum. Only then, they can really make use of S-corp's tax benefits

For various businesses

If you’re just starting out and don't expect to raise outside capital for quite some time, you can choose an LLC. Once the store picks up, you can elect to be classified as an S-corp

Single member LLC would be ideal during the initial days. After you start earning more than $60k per annum, you may want to be elected as an S-corp

Choosing LLC and electing your LLC as a corporation would save some money on taxes as compared to the default multi member LLC. Alternatively, you could also choose to be elected as an S-corp for additional tax savings.

For a high growth SaaS company, C-corporation is usually the better business entity. Only a corporation can issue stock to your employees, contractors or investors. S-corps have a limitation of a maximum 100 individual shareholders. That means institutional investors cannot be shareholders.

Tax treatment

How are LLC and S-corp treated by IRS?

LLC is governed by state statues. It is only a legal entity, not a new tax entity. By default, LLCs with a single member are treated as a sole proprietorship and multiple members are treated as a partnership. They have a pass-through income, meaning the business income(called distribution) is transferred to the members and are not taxed at the LLC level. Members pay taxes at their individual level. There is no double taxation. Members pay self employment tax (15.3%) on the entire distribution.

S-corp has a pass-through income like an LLC. This means business income is not taxed at the corporation level and is automatically passed through to the shareholders. In addition, shareholders are required to be hired as employees. That means shareholders receive 2 kinds of income from an S-corp: distribution & salary. None of the two is taxed at the corporation level. Therefore, there is no double taxation. All the taxes are paid at the individual level. However, shareholders do not pay self-employment tax(15.3%) on their distribution. That's the main tax savings in an S-corp.

Tax rates

How exactly are LLC and S-corp taxed?

Single member LLC

A single member LLC usually pays 2 types of taxes: payroll tax and franchise tax. Members of the LLC pay income tax at the individual level.

32-37%

Top 3 personal income tax rates

21%

Corporate income tax rate on profits

23.8%

Individual income tax on shareholder's dividends

6.2%

Employer portion for social security tax

1.45%

Employer portion for medicare tax

Total FUTA tax including state credit

S-corp

S-corp usually pays 2 types of taxes: Payroll tax and franchise tax. In addition, shareholders pay income tax at their individual level.

32-37%

Top 3 personal income tax rates

15.3%

Self employment tax

6.2%

Employer portion for social security tax

1.45%

Employer portion for medicare tax

Total FUTA tax including state credit

Costs

How much do an LLC and a S-corp cost?

The costs to register and maintain an LLC and an S-corp depend on a lot of factors: state of operation, nature of business, etc.

Single member LLC

LLCs are considered relatively less expensive.

One time

Formation fee for the State

$90

Reserve business name

$75

Annually

Registered agent costs

$100 - $300

State franchise tax

$50 - $800

Quarterly

Income tax

21 - 37%

Payroll tax (employer)

7 - 10%

Service charges

Lawyer

$100 - $500/hour

CPA

$100 - $500/hour

S-corp

Due to its complex structure, S-corp is usually slightly more expensive.

One time

Incorporation fee for the State

$90 - $100

Reserve business name

$75

Annually

Registered agent costs

$100 - $300

State annual report fees

$50 - $75

Quarterly

Individual shareholder Income tax

21 - 37%

State Income tax

0 - 1.3%

Payroll tax - employer contribution

7 - 10%

Service charges

Lawyer

$100 - $500/hour

CPA

$100 - $500/hour

FAQ

S-Corp requires slightly more paperwork than LLC due to its hiring requirements. There are a couple of annual reports to be filed with the federal and state agencies. You will also have to conduct board meetings and record minutes for it. However, most of them are one-time and may not require a lot of your time.

For single and multi member LLCs, members cannot be the employees just to pay themselves a salary. It is almost illegal to do so. However, it is required to pay shareholder a reasonable salary in an S-corp.