Managing Partner
When forming a new business or company, owners must decide which type of legal entity to form. Many people do not understand the difference between limited liability companies and S corporations.
Fortunately, once you have been provided the criteria by an experienced business attorney, the decision about which business entity to form is not that complex.
Initially, S corporations are also known as “S Corps.” These entities are taxed through the Internal Revenue Code, Subchapter S. They are not a type of business entity but a tax classification type. It is important to note that limited liability companies (LLCs) are only taxed once.
The decision about which type of business entity to form can make a profound difference in the amount of your tax obligations. It is vital to understand the difference between an S Corp and an LLC to make your company as successful as possible.
Understanding Limited Liability Companies
LLCs are a particular type of business structure intended to protect the owners’ personal interests. Because an LLC is legally distinct from the owners, their personal finances and assets are generally unaffected by the potential failure of the business.
Owners of an LLC are known as “members.” These business entities can be owned by a single individual or multiple parties including other entities.
Limited liability companies are hybrid entities between corporations and partnerships. Currently, in most cases, small and medium-sized businesses are structured as LLCs.
This is because LLCs are the simplest business entity structure. Entrepreneurs prefer the LLC structure as it provides a significant amount of flexibility.
Profit-sharing options and management approaches are much easier to customize when running as an LLC. These entities are taxed in the same way as general partnerships, in most cases.
The way that an LLC is taxed will depend, in part, on how many owners, or “members,” it has.
Understanding S Corps
S Corporations are not a type of business entity. Rather, an S Corporation is a type of tax classification.
LLCs and corporations can both be classified as an S Corporation for the purposes of taxation. S Corporations do not pay corporate income tax.
With an S Corporation, the business’s profits are accounted for through the owners’ personal tax returns.
Not every type of business can be taxed as an S Corp. To pursue S Corp status:
- The entity must be a U.S. business
- Shareholders can only be individuals or specific trusts
- Corporations and partnerships cannot be shareholders
- The entity can have only one class of stock
This tax categorization can have many advantages. Businesses that are structured as corporations can avoid double taxation. Otherwise, profits would be taxed at both the corporate and shareholder levels.
For LLCs, this tax classification allows you to be an employee of the company. In many instances, S Corp classification can save owners significant amounts of money.
Distinctions Between an S Corp and an LLC
The most important difference between these two types of business entities is how they are taxed. LLCs have fewer formalities and lower reporting requirements than S corps, making them easier and cheaper to manage. LLC owners pay self-employment tax on all profits, while S corp shareholders may pay less in total taxes.
LLCs are classified as “pass-through” entities. This means that the income from a limited liability company passes through to its members.
On the other hand, S Corp businesses are known as “accounting” entities. This means that the company calculated deductions and revenue internally before allocating assets to individual stakeholders.
Another key difference between an LLC and an S Corp is who can own the business. Most states allow corporations, partnerships, and individuals to be owners of an LLC.
On the other hand, only certain parties are legally permitted to be shareholders of an S Corp. This includes permanent residents and citizens of the United States.
LLCs can have unlimited members, including non-U.S. residents. S corporations are limited to 100 shareholders who must be U.S. citizens or residents and cannot include corporations, LLCs, partnerships, or most trusts.
Contact a Skilled Business Attorney
When you have questions about the right structure and tax classification for your business, reach out to a legal professional. The accomplished business attorneys at Woods Lonergan can review your circumstances and provide you with reliable legal advice.
We have years of experience helping entrepreneurs establish the type of legal business entity that is right for them. Contact Woods Lonergan today for an initial no-cost legal consultation.