LLC stands for limited liability company. LLCs are granted by individual states. LLCs have few requirements and are attractive because of their liability protection and potential tax savings. This means that any debts and liabilities incurred to the business are separated from the business owners.
S Corporations are for smaller companies, as they are only allowed to have up to 100 owners. Furthermore, owners are only able to get common stock, meaning that there are no preferred voting shares. S corporations are only taxed once, but do have ongoing compliance fees. S Corporations also require all owners to be U.S. citizens or residents.
LLC’s tax structure is bestowed on the owners, making it an easy process. This means that, unlike corporations, it is not taxed as a separate entity. Any taxes owed are distributed to the owners of the LLC. This is a major convenience because this means that if you do nothing as an owner of the LLC, you will find the taxes bestowed upon you personally. Let’s assume you own an LLC with two other owners and earned a $10,000 profit. The taxes owed on this profit will be evenly distributed to all three owners.
Starting an LLC is quite simple: an operating agreement needs to be established, which is essentially a contract between the owners. The only other major form is the 1065, which is reported to the IRS to ensure that the membership and income is all properly reported. From there, the taxes are distributed on a standard 1040 tax return. Members of an LLC are taxed similar to a sole proprietorship, and members are considered self-employed. As the business becomes more profitable overtime, it may make sense to later file as an S Corporation.
Starting an S Corporation is more complicated than an LLC. In order to start an S Corporation, a 2553 election by a small business corporation must be signed by all shareholders. This allows the corporation to have a federal tax ID number. A major flaw of being an S corporation is that it is taxed twice, both as a corporation and to shareholders. C Corporations are taxed twice as it is subject to corporate income tax as well as shareholders being taxed for profits.
S corporation vs LLC? An LLC is able to have unlimited owners, which can be a major attraction for companies that do not want to go public who want to have many owners. However, you need to have all owners agree to any transfer of ownership, which can present many issues that an S corporation is able to avoid. LLCs are never able to go public, which can put a ceiling on a company if they ever have the desire to go public. Be sure to check out this article by Vetted Biz to compare LLC to both an S Corporation and a C Corporation.
|LLC Pros||S Corporation Pros||LLC Cons||S Corporation Cons|
|Unlimited Owners||Can go public but more complicated than a C Corp||Cannot go public||Up to 100 Owners|
|Board of Directors not required||Recognized internationally||Not recognized internationally (Can be taxed as a corporation abroad)||Requires board of directors|
|Easy and straightforward process to start an LLC||Majority of shareholders have control||Ongoing filings and fees||All shareholders must be U.S. citizens or residents|
|Can always file as an S Corp or C Corp||–||Need all owners to be in agreement||Can only have one class of stock|
|Only taxed once||–||Varies state by state||Double taxation|
|Tax process simple||–||–||–|
It is important to evaluate the pros and cons listed above of both an LLC and an S corporation. The major question you should be asking yourself when considering an S corporation is will the company’s profits be much greater than what you will reasonably pay yourself and all the other shareholders.
A common example of an LLC are small real estate companies. Many people have begun investing in real estate as a method of earning passive income. However, it is risky to operate as a sole proprietor in case of a liability situation. This way, the LLC will absorb any wrongdoing or liabilities rather than the individual owner.
Additionally, LLC’s allow there to be multiple partners, allowing these individuals to pool capital together to try and grow the LLC.
Meanwhile, a famous example of an S Corporation is Scrub Daddy Inc. Scrub Daddy became a globally recognized brand due to its success on shark tank. Scrub Daddy started off as a small single sponge company that now offers a wide range of products. Shark Tank Host and QVC legend Laurie Grenier invested in the brand, and the business today is valued at over $209 million. While S Corps can be small in terms of number of owners, they can still become highly profitable companies.
While LLCs and S Corporations are very similar in nature, they operate quite differently. The primary difference is that LLCs have owners, while S Corps have shareholders. LLCs can easily become S Corporations later on if revenue and profits begin to be at a rate that makes more sense. LLCs allow significant flexibility, but they vary depending on a state by state basis. Furthermore, LLCs are not recognized internationally and can face taxes as a corporation abroad. S Corporations are limited to 100 shareholders, which can create ceiling issues if the company continues to grow, making a C Corporation more attractive. LLCs do not face double taxation as C and S Corps do. However, there are many ongoing fees that LLCs endur. Ultimately, the decision of whether to be an LLC or an S corporation entirely depends on profitability, and how much the business is expected to grow.
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