S-Corp vs. LLC – Basics & Differences

A Limited Liability Corporation (LLC) or an S Corporation (S-Corp, Subchapter S of Chapter 1 of the Internal Revenue Code) is the most likely choice for most entrepreneurs looking to set up a business structure, or for those looking to change from an existing structure. While both have similarities such as limited liability protection for principals and pass through taxation, the number of varied features exclusive to an LLC and an S-Corp make it necessary to understand these differences before incorporating the right kind of business structure.

But first, let us list the basic and common features for both types. S-Corp & LLC Similarities:

• Limited liability protection for owners, which offers legal protection to personal assets from the debts and liabilities of the business.
• Pass through taxation facility where the business returns are forwarded to the personal tax returns of the owner, where the necessary tax is to be paid by the individual, rather than the business. This avoids double taxation, once at the business level and the second time on personal income derived from the net profits of the business.
• Registration and reporting for both is done at the State level, with records of creation and annual filings being maintained by the state.

S-Corp & LLC Important Differences:

• Ownership issues: An LLC is allowed to have an unlimited number of owners, while the S-Corp is restricted to a 100 shareholders. Non-US residents are allowed to own an LLC, subject to fulfillment of certain preconditions. An S-Corp cannot reside, or be owned, under the umbrella of other C or S Corporations, LLCs, partnerships or trusts. An LLC is not subject to this restriction. By the same token, an LLC is allowed to create further subsidiaries under its own umbrella without any restrictions.
• An S-Corp has strict regulations governing the maintenance of corporate records and annual functions, such as well defined bylaws, issual of stock options, necessary annual meetings of directors and shareholders and accurate records of the minutes of these meetings. With LLCs, all these issues are not mandated, but more of a matter of preserving the same for internal purposes and for use in case of audits or financial transactions with lenders or investors.
• The owner of an LLC has the freedom to assign roles within the company, or assume as much responsibility as he wants to himself. An S-Corp, on the other hand, needs a board of Directors, which oversees the management of the company, including appointment of operating officers who carry out the day to day duties of the company.
• Ownership, or part ownership, of an S-Corp is readily transferable, via sale of shares, while transfer of ownership in an LLC is slightly more complicated, requiring the acquiescence of all registered members (owners) of the LLC.
• For tax purposes, an S-Corp has some inherent advantages over LLCs. For example, with an S-Corp, all earnings above fair market salary levels are considered to be a distribution of profit, and not as wages, thus avoiding employment tax. Conversely, with an LLC, where the owner is essentially considered to be self-employed, any net monies accrued above fair market salary are still considered to be wages, and are liable for employment taxes.

In summary, while an LLC has a lot of flexibility and relatively lax regulation, an S-Corp is a very sound choice for businesses which expect a high growth, with new employees being added to the payroll and a surge in income in every quarter. Thus, if you are just starting off with a new business, and you are unsure of the potential or direction of growth, an LLC would be the best choice. In case you have a soundly mapped plan for steady growth and fresh infusions of capital investments, an S-Corp with it’s tax advantages and ability to cater to a company with a growing number off employees and complex tax returns is probably the best choice.