When comparing legal structures for a company, many business owners end up comparing a limited liability company -- LLC -- with a special type of corporation called an S corporation. Both legal structures offer the benefit of limited liability for the company owners, as well as favorable income tax treatment that's similar to a partnership. However, the structures differ in other areas, such as management flexibility and the number of allowed owners.
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An S corporation is formed in the same manner as a regular corporation, sometimes referred to as a C corporation, with one or more persons filing the appropriate documents under state law to bring the corporation into existence. The business becomes an S corporation when the corporation files an election with the IRS -- Form 2553 -- to receive special tax treatment. Unlike a C corporation that pays tax on corporate income with the shareholders then paying tax on dividends, the income and losses of an S corporation are passed through to the shareholders like a partnership, and thereby avoid double taxation.
An LLC is also formed under state law, with one or more persons filing the appropriate documents to bring the LLC into existence. Like an S corporation, an LLC can make an election regarding its tax treatment. Because the IRS does not recognize an LLC for federal tax purposes, an LLC's owners can choose to be taxed as a corporation -- even an S corporation -- a partnership or, in the case of a single-member LLC, a sole proprietorship. LLCs make this election by filing Form 8832 with the IRS.
Tax Status Qualifications
In addition to stricter management requirements, S corporations also have to adhere to stricter rules than LLCs in order to qualify for the partnership-like tax treatment. IRS rules mandate that an S corporation can only be a domestic corporation with a maximum of 100 shareholders, and that it issues only one class of stock. Additionally, its shareholders cannot be a partnership, corporation, non-resident aliens or certain other individuals and entities. An LLC can have an unlimited number of members, make special allocations of profits and losses, and include other business entities as members.
An S corporation must follow the same state laws as all other corporations in the state regarding management and adherence to formalities, such as holding annual shareholder and director meetings, as well as maintaining minutes of meetings and corporate resolutions. This is where LLCs significantly differ from S corporations. State LLC laws were specifically enacted for the purpose of doing away with such corporate formalities, yet still provide the benefit of limited liability to LLC owners. While corporations must have a president, secretary and a set number of directors depending on the number of shareholders, an LLC can be managed by all members, or designate one or more managers, who may or not be members, with this authority. An LLC is permitted to be run by one manager who does not have to follow the record-keeping formalities of an S corporation.