S Corporations Vs. LLCs
When setting up a new business, every owner is faced with the question, “Which corporate structure is right for my business?” While there are more than two business entities to choose from, LLCs and S corps are two of the most common types of business structures.
However, many people do not understand the differences between S corporations and LLCs, making it harder for them to make an informed decision when choosing a business structure. Our business formation attorney at Law Offices of Gretchen Cowen, APC, can help you decide whether an LLC or S corporation is a better choice to fit your business. For our law firm has helped clients across California at every step of the business formation process.
The Definition of an LLC and an S Corp
A limited liability company (LLC) is a business entity type that combines the flexibility of a partnership with the liability protection enjoyed by corporations. An LLC is a popular choice among startups and small businesses because LLCs are relatively easy to set up and do not have to follow the corporate formalities associated with corporations.
Unlike an LLC, an S Corp is not a business entity. An S corporation is a tax designation available to certain corporations and LLCs that allows them to protect their assets from double taxation. Unlike a C corporation, in an S corporation, business income, losses, and other tax items pass through to its shareholders, which allows it to be taxed on a "flow-through" basis similar to a partnership or LLC.
What Are the Differences Between LLCs and S Corporations?
The biggest difference between an LLC and an S Corp is that the former is a business entity while the latter is a tax status. LLCs can attain S corporation status if they meet certain requirements, one of which is to have less than 100 shareholders. Moreover, there are other prominent differences between an LLC and an S corporation you should be aware of when forming your business:
Ownership. An LLC can have an unlimited number of members, while S corporations cannot have more than 100 shareholders. S corporations also limit ownership to individuals, trusts and estates, while LLC owners can be a corporate entity.
Residency of members/shareholders. While the tax code prohibits non-resident aliens from being shareholders in an S corporation, there are no limits regarding the residency of LLC members.
Taxation. By default, LLCs are taxed like a partnership or sole proprietorship. LLC members are considered self-employed and are legally required to report business income and expenses on personal tax returns. With S corps, the profits and losses of the business are passed through to the shareholders and are reported on the shareholders’ personal tax returns.
Management structure. A corporation that qualifies for an S corp tax status must have a board of directors who make high-level decisions and oversee the management of the business. Electing directors to the board is the responsibility of the shareholders. LLCs, on the other hand, are run by managers or directly by the members. An LLC can be either member-managed (the default in California) or manager-managed. As the name suggests, owners (members) are responsible for overseeing the management of the company if the LLC is member-managed or members can hire managers or appoint individual members to take on this responsibility if the LLC is manager-managed.
Profit sharing. LLCs are more flexible than S corporations in terms of profit-sharing among members. An LLC can use an operating agreement to dictate the percentage of profits for each member of the company. In S corporations, shareholders receive their profits based on their percentage of ownership. However, unlike the profits of LLC members, dividends paid to shareholders in S corporations are not subject to a self-employment tax.
Ease of formation. Compared to S corporations, LLCs are generally easier to establish and involve fewer formalities and eligibility requirements.
Cost to establish/elect. The cost of forming an LLC or electing an S-Corp status varies depending on various factors, including the state where you do business, whether the company will be bringing in outside investors, the management structure, and whether your company conducts business across state lines. In general, however, an LLC is cheaper to establish and maintain compared to an S corporation.
If you need assistance in navigating the differences between S corporations and LLCs, seek legal guidance from our attorney at Law Offices of Gretchen Cowen, APC. We can guide you in picking the business structure that is right for your company.
Can You Switch Between an LLC and an S Corporation?
Yes, it is possible to switch between a limited liability company and an S corporation. First, since an S Corp is a tax status, your business can be both an LLC and an S Corp at once. When a business files for an S corporation tax status at the federal level, it can maintain its state-level LLC status and enjoy the benefits of both an LLC and an S corp. In addition, an LLC may later convert into a corporation and make an S Corp election at that time.
Get the Support and Guidance You Need
The information above only scratches the surface of the differences between S corporations and LLCs. Contact the Law Offices of Gretchen Cowen, APC, to get personalized support and guidance from our attorney. Picking the right structure for your business is a major step toward future success. Reach out to our office in Carlsbad or La Jolla to schedule a consultation with attorney Gretchen Cowen.