Comparison: S-Corp vs. LLC
As entrepreneurs prepare to file the paperwork for their first company, one of the most significant decisions they must make is deciding how their new business will be classified. There are numerous options available, but for many, the choice boils down to S-Corp vs LLC. Learning about the differences between an S-Corp and an LLC can help new business owners make an informed decision when they register their new business.
Defining Both an S-Corp and an LLC
When comparing S-Corp vs LLC, it's important to understand the basic definitions of both business structures. An LLC is a business entity. Although individual states may have different regulations and interpretations regarding LLCs, generally, they are business entities that are entirely separate from their owners. LLCs can have multiple members, including the owner.
Many new business owners choose to register as an LLC because filing a "Limited Liability Company" offers them a way to protect their assets. LLCs also tend to have fewer reporting obligations than corporations. In summary, an LLC is a business entity that is similar to a corporation but could be particularly beneficial for new business owners because of liability protections.
S-Corps are unique because they strictly refer to the way a business chooses to file its taxes. While S-Corps are technically business entities, the moniker "S-Corp" is used to demonstrate how the company has chosen to be taxed. Thus, because they operate as entities, S-Corps do protect their owners from debts and liabilities. They also allow for pass-through taxation, which allows business owners to pass their business income taxes to their personal tax returns.
It's plausible, and even likely, that an LLC business owner registers as an S-Corp with the Internal Revenue Service. When filing taxes with the IRS, companies cannot choose an "LLC" option. Instead, they must choose between one of the following classifications:
- Sole Proprietorships (Tax From 1040)
- Partnerships (Tax Form 1065)
- C Corporations (Tax Form 1120)
- S Corporations (Tax From 1120s)
To summarize S-Corp vs LLCs, LLCs are a type of business entity. The central determination entrepreneurs must make when deciding whether they would like to file as an LLC is their corporate structure and liability exposure. Entrepreneurs must then determine how they want the IRS to tax them. This is where the decision to file as an S-Corp comes into play. Both C-Corps and LLCs can elect to file their taxes as an S-Corp.
Primary Differences between S-Corps and LLCs
In addition to the fundamental definitions of S-Corps vs LLCs, some other requirements set the two apart. Some of these criteria may make it easy for business owners to make the S-Corp vs LLC decision. One of the biggest involves the company's membership. LLCs can have an unlimited number of members. This means that as a company grows, they do not have to change their entity structure.
S-Corps, on the other hand, can have no more than 100 shareholders. While S-Corps could be advantageous for small businesses, the company could have to change their filing status with the IRS as it grows. Additionally, if a company were ever to go public, they would probably surrender their S-Corp status.
In addition to the requirements for the number of members in an S-Corp vs LLC, there are also requirements regarding the membership makeup of the two. An LLC can have members who are not U.S. citizens or residents. S-Corps cannot have members who are non-U.S. citizens or residents.
Weighing the Tax Benefits between S-Corps and LLCs
If a business still meets the criteria for both an S-Corp and an LLC, new owners should take time to consider the tax benefits of both. When the only member of the LLC is the business owner, the IRS would consider the company to be a sole proprietorship. In this case, the business owner would report all business expenses and income on their personal tax returns. The gains or losses that their LLC saw during the past year would be taxed at the personal income tax rate, as opposed to the corporate tax rate.
If business members choose to classify as an S-Corp, they would still pass income through to their personal tax returns. However, they will be considered employees of the business as well. Their books would show each member's salary as a business expense. Any profits that remain after deducting business expenses would pass through to the owner's personal tax return.
Since the business owner would have to pay everything on their personal tax return anyway, entrepreneurs often wonder if there is any difference between the two. But when new owners begin to consider Social Security and Medicare taxes, it’s easy to see the significant role this decision could make.
This is because employers pay half of all Social Security and Medicare taxes, with employees paying the other half. LLC owners not registered as an S-Corp must pay Social Security and Medicare taxes on all business profits. Those owners who file as an S-Corp only have to pay those taxes on an employee's salary. Registering as an S-Corp could save owners a significant amount of money.
Before business owners decide which is right for them, an S-Corp or an LLC, they should first consider the primary criteria. If their LLC has more than 100 members or has members who are nonresident aliens, the choice will have already made for the owner. The business could not declare their new LLC to be an S corporation.
However, if the LLC does meet the requirements for an S-Corp, it would be wise for business owners to consider filing their taxes under this option. They should begin by coming up with what the market believes to be a reasonable salary for their position in their industry. Then, business owners should determine if their business would still have profits left over after they paid themselves this salary. If the company would not have any profits remaining, they may not want to switch to an S-Corp.
It’s crucial that business owners make the correct tax election for their business. Speaking with an accountant who is knowledgeable on tax matters can help business owners make the correct tax decision.
Business Filing Section