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SuraLinkWritten by Sarah Shirley, Supervisor
When it comes to choosing a business structure, it’s easy to feel overwhelmed by the acronyms and fine print. Whether you’re starting a new company or thinking about restructuring an existing organization, two of the most popular options for small businesses are Limited Liability Companies (LLCs) and S-Corporations. While both offer personal liability protection and avoid double taxation, there are many key differences that can have a lasting impact on your business.
Tax Treatment
- LLC: By default, single-member LLCs are treated as disregarded entities, meaning there’s no separate business tax return. You report the business activity on your personal tax return, eliminating any additional costs associated with another tax filing. Multi-member LLCs are treated as partnerships and are required to file a separate business tax return. LLCs also have the option to elect S-corp status later if it becomes more tax-efficient.
- S-corp: Always required to file a separate business tax return, even for a single-owner business.
Salary vs. Distributions
- LLC: Owners typically take distributions, and the full amount of business profit is generally subject to self-employment tax. There is no formal payroll requirement unless there are employees.
- S-Corp: Owners who work in the business must be paid a reasonable salary, which is subject to payroll taxes. Additional profits can then be taken as distributions, which are not subject to payroll or self-employment taxes, potentially lowering overall tax liability. However, while the S-corp structure can offer tax savings, it also requires more administrative work, such as running payroll and filing employment tax forms.
Ownership and Eligibility
- LLC: Extremely flexible. Owners (called “members”) can be individuals, corporations, foreign entities, or even other LLCs. There are no residency or citizenship requirements.
- S-corp: Restricted to 100 shareholders, all of whom must be U.S. citizens or residents. Only individuals, certain trusts, and estates can hold shares – corporations and partnerships are not allowed. S-corps must also be domestic and operate within eligible industries.
Profit and Loss Allocation
- LLC: Offers flexibility in allocating profits and losses, which don’t have to mirror ownership percentages. This can be customized through an operating agreement, making LLCs a popular choice for real estate ventures and investment groups.
- S-corp: Income and losses must be distributed strictly in proportion to ownership. No special allocations are allowed.
Administrative Requirements
- LLC: Usually simpler to manage. There are no requirements for annual meetings, issuing stock, or maintaining corporate minutes (although it is a good practice).
- S-corp: Must follow more formal corporate procedures, including annual meetings, documented minutes, adopting bylaws, and issuing stock.
Ownership Transfers
- LLC: Transferring ownership can be more complicated and may require member approval unless otherwise stated in the operating agreement.
- S-corp: Ownership is held in the form of stock, which can make transfers more straightforward. This is ideal for businesses planning to grow or transition ownership over time.
Which Is Right for You?
- LLCs offer maximum flexibility and are a great fit for businesses needing customized ownership structures, like real estate and investment groups. They also tend to be easier to maintain for solo owners or small teams who want fewer administrative burdens.
- S-corps can provide significant tax savings through payroll/distribution splits but come with stricter rules and more paperwork. They’re often better suited for businesses planning for growth or eventual sale, where ownership transferability and structure are key.
We recognize that choosing your business structure is a big decision, but BMSS is here to help. Reach out to your BMSS tax professional today so we can help you find the best fit. Visit our website or call our office at (833) CPA-BMSS.