Limited liability companies (LLCs) and S corporations are distinct business entities. State laws typically govern the rules for formation, management and dissolution of both LLCs and S corporations. These state laws for each entity vary somewhat from state to state. However, the main characteristics of each business entity are usually the same in each. These two business entities have similarities, differences, advantages and disadvantages.
An LLC is typically a business entity that combines characteristics of a C corporation and partnership -- or sole proprietorship for single-owner LLCs. It offers flexibility for how owners, known as members, can operate the company. On one hand, an LLC generally protects its members from being personally liable for the debts of the company and for negligent acts of other members, like a C corporation. On the other hand, the IRS permits LLC members to elect whether to get taxed like a corporation, which is double taxation whereby members are taxed and the company itself is taxed, or to get taxed like a partnership, whereby only the members' personal returns are taxed. Therefore, an LLC provides the liability protections of a C corporation and the tax incentives of a partnership.
Shareholders must incorporate S corporations under state requirements in the same way they would for a C corporation. However, to form an S corporation, the incorporators elect to get taxed under Subchapter S of the Internal Revenue Code rather than Subchapter C -- where C corporations get taxed. By making this election, S corporation shareholders elect flow through taxation like a partnership. That means the gains and losses of the S corporation flow through to the individual shareholders' personal income tax returns. This election avoids the double taxation to which a C corporation is subject. An S corporation also enjoys limitations on shareholder personal liability.
The main difference between an LLC and an S corporation is each entity’s requirements. Filing for an LLC has very few requirements, which vary from state to state. The typical requirements are that at least one member file Articles of Organization, pay the appropriate fee and submit any additional required paperwork. To form an S corporation, the business must meet requirements set forth in the federal Internal Revenue Code. The requirements include that it be a U.S. based corporation, only issue one class of stock, have only 100 or less shareholders composed of individuals and/or certain trust and estate shareholders -- not corporations or partnerships as shareholders.
Differences in Tax Treatment
Another difference is in tax treatment. LLC members pay a self-employment tax, which is 15.3 percent as of 2010, of the company’s net income. For an S corporation, only the salary the owner pays himself is subject to the self-employment tax. Any additional distribution by the S corporation is not subject to that tax. On the other hand, filing tax returns for an S corporation is considerably more complicated and includes payroll tax filings, which must be filed frequently and on time throughout the year.
Each business is unique. The decision to form an LLC or S corporation requires careful consideration of all relevant state and federal laws and regulations as well as relevant tax, management and liability concerns. It should only be made after consulting a qualified attorney, licensed to practice in the appropriate jurisdiction, and/or tax professional.