Tax status is considered a disadvantage of incorporation, according to the Small Business Association. Corporate income is taxed, then shareholders are individually liable for income taxes on any dividends they receive, resulting in double taxation. Subchapter S allows corporations to be taxed as partnerships, potentially avoiding double taxation provided the corporation maintains all the subchapter’s requirements. Since an LLC is not recognized as a business entity for federal tax purposes, an LLC must elect its own business entity classification, and can file as a sole proprietorship or partnership.
An LLC is a hybrid business structure allowed by state statutes, while an S-Corp is a type of corporation governed by federal and state laws. Owners of an LLC are called “members,” and can include individuals, corporations and other LLCs. In contrast, shareholders of an S-Corp cannot be partnerships or corporations, according to IRS regulations. Furthermore, as of November 2010, an S-Corp is limited to 100 shareholders, while there is no limit to the number of members an LLC can have. The Small Business Association notes that an S-Corp is usually more expensive and time-consuming to form than an LLC or partnership.
An S-Corp, like any corporation, is an independent entity separate from its owners. As such, an S-Corp essentially lasts in perpetuity and does not dissolve when ownership changes. In contrast, an LLC’s duration is limited, and is typically specified when the LLC is organized, although members can elect to continue an LLC for an additional term after the original term expires. An LLC always dissolves with any change in ownership.
An S-Corp must fulfill the same reporting and records requirements as other corporations, and must have regular meetings of directors and shareholders. An S-Corp must also continuously meet all IRS requirements to maintain subchapter S tax status. Notably, if a shareholder works for the S-Corp, he must be paid market-value compensation for his services. This requirement does not exist with LLCs, which also typically have far less rigorous record-keeping and reporting requirements than corporations.