Limited liability companies, or LLCs, and Subchapter -- or S -- corporations are legal formation options to consider when starting up your small or family-owned business. An LLC can take the taxation form of a partnership or a corporation, so an LLC and an S corp are not mutually exclusive. However, most LLCs are organized as partnerships.
LLCs can be owned by any number of combinations of businesses and individuals, or be owned by a single individual. Federal tax regulations place limitations on the number of owners and qualifications of owners of S corp. Nonresident aliens, corporations and partnerships cannot own shares in an S corp, but may own membership interests in an LLC. S corps may have no more than 100 shareholders, but there is no restriction on the number of LLC members, though some state professional licensing regulations may restrict ownership of professional LLCs, such as those formed for the purpose of managing a law practice or medical office.
IRS regulations require S corps to issue only one class of stock, so all shareholders must have the same rights and ownership interests. When forming an LLC, you may create different classes of membership and assign each class a different set of ownership and management rights.
Both S corps and LLCs have a taxation advantage over ordinary business corporations, in that the income to the business entity is not taxed at the business or corporate level, but passes through to be taxed as income to the shareholders or members. However, shareholders in S corps only pay Medicare and Social Security taxes on income which they receive from the corporation as employment compensation, while LLC members usually pay these taxes on all LLC income. Additionally, LLC members ordinarily pay income tax even on LLC income which is not distributed, while S corp shareholders do not pay income tax on money which is retained by the business for business development.
S corps, like other corporate forms, must hold an annual meeting and keep careful minutes of corporate business conducted at that meeting. LLCs are not required to hold a formal annual meeting. This informality may be an advantage in some circumstances, yet because LLCs are managed by all members rather than a statutorily mandated set of officers, the entity may grind to a halt if all members do not communicate regularly and adopt an efficient method of decision-making to move the business forward.