S Corp vs. LLC

by Rob Jennings J.D.
S corps and LLCs are both popular forms for small business.

S corps and LLCs are both popular forms for small business.

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Among the many business organization choices facing the start-up entrepreneur stand the limited liability company (LLC) and Subchapter S corporation (S corp). Both forms offer features that make them attractive vehicles for both small and large businesses alike, with several similar advantages that can make picking one over the other difficult in some cases. Deciding on whether to form an LLC or incorporate and file for Subchapter S status requires an understanding of each form.

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How They Are Alike

LLCs and S corps have several important features in common. Both offer their owners--called "members" in LLCs and "shareholders" in an S corp--the protection of limited liability from suit for the torts, or civil wrongs, committed by company employees or other owners. Additionally, both offer their owners the ability to receive "pass-through" tax treatment, where company profits are reported on the owners' individual tax returns. Traditional corporations offer limited liability to shareholders but pay tax both on the corporate level and again on the individual level when shareholders must report dividends and capital gains.

Differences in Ownership

An LLC offers a great deal of flexibility in terms of who can be a member. Individuals, trusts, estates, corporations and other LLCs can all own membership interests in an LLC, allowing them to add another layer of limited liability to an existing business structure. While a traditional corporation is allowed to be a shareholder in another corporation, current law limits who can own shares of an S corp. Only individuals, estates and certain trusts can be shareholders; partnerships, corporations and non-resident aliens are excluded. These excluded individuals could, however, own membership interests in an LLC.

Differences in Transfer of Ownership

State law governs the organization and operation of both LLCs and corporations, but different rules apply to each form in transferring ownership interests. S corporations, like all corporations, have stock that can be sold, inherited, given away or seized by creditors, although voluntary and involuntary transfer provisions of a closely held corporation's shareholder agreement can limit these occurrences. LLCs, on the other hand, face transfer limitations not only in their members' operating agreement but also by state law. Some states do not allow an LLC to continue after a member's death or bankruptcy.

Differences in Interstate Operation

While all states recognize LLCs and corporations, differences exist as to what sort of entities are allowed to operate in each form. An association of lawyers or doctors may operate as a professional limited liability company (PLLC), limited liability partnership (LLP) or professional corporation (PC) in their home state but find that the contiguous state does not allow their profession to form an LLC or a corporation. To minimize operational complexity and maximize brand equity, many businesses that operate in several states choose to organize in a form that is recognized for their business in all states of operation.