S. Corp vs LLC: What is the difference?
Some big questions that freelancers, self-employed workers, entrepreneurs, and individuals who dream of starting a business always ask themselves; should I incorporate? How do I do that? When will I know if it’s the right time? What type of corporation should I be? And down the rabbit hole they go. It can be overwhelming! My goal here is to help pull back some mystery surrounding two very common business types. Let’s get into it.
S.Corp
What’s an S. Corporation? Well, S. Corp stands for “Subchapter Business Corporation” or “Small Business Corporation”. That was easy, no? Don’t get too excited yet. There are key details relating to an S. Corp you should know about.
There can only be 100 or less shareholders/members.
Income can be passed on to shareholders so that they avoid what’s called double taxation. Double taxation is when both the business income and the income of it’s employees and shareholders/members (who can also be employees) are taxed.
It’s not limited to income; losses, deductions and credits can be passed to shareholders/members as well. Essentially, taxes are paid on the personal level, not the corporate level.
What’s a shareholder or member? Someone who owns a share or piece of the company.
There are some inherent tax advantages to being a S. Corporation. However, some of these advantages cause extra scrutiny by the IRS so you want to make sure you have a good tax accountant filing your taxes and providing sound advice. Want an example?
Well, shareholders/members can be employees. This means that shareholders/employees not only earn a salary (which they have to do) but can also receive dividends or “corporate distributions”. This corporate distribution can end up being tax-free. Nice perk! This is why the IRS pays extra close attention that corporate distributions aren’t delivered in place of salaries which are always taxable.
Food for thought: In general if a business has multiple people running the company, it may be more advantageous to be an S. Corporation than an LLC. This is because there are more rules surrounding the structure and operation of an S.Corp.
Of course when talking about taxes and the federal and state governments, things can get a bit more complex. However, the above information is the main tenets of an S. Corp. Essentially, an S. Corp is more about how to manage taxation as a business than being a formal business entity.
LLC
What’s an LLC? This is probably one you’re most familiar with. LLC stands for Limited Liability Company and unlike an S.Corp, it is considered a business entity because it meets a legal entity definition that an S. Corp doesn’t meet.
LLCs have to pay self-employment taxes on all income (remember the corporate distributions that aren’t always taxed with an S.Corp? No can do here.)
LLCs can have an unlimited number of members or shareholders. Business owners are referred to as members.
LLCs are designed to protect the personal property and assets of the members in case of legal suits and other threats to members assets. Legally any debt collector or plaintiff can only go after the property of the LLC and not it’s members/shareholders.
Like an S.Corp an LLC can be a pass-through entity, meaning that income, losses, deductions and credits are reported on the individual level. This is one option. It can also be taxed on it’s own depending on how it was set up.
S.Corps are more of a federal level distinction while LLCs are more of a state level distinction. When setting up either entity you will have to file articles of incorporation and follow other steps and pay certain fees. However, LLC requirements change from state to state.
LLCs have more flexibility in business setup, operations and framework than S.Corps. S. Corps can be more cumbersome and rigid as well as expensive to manage.
Although either one of these business types may seem better than the other, one should always consult with a tax attorney/account before incorporating. The context of which state you live in and what kind of business you’re conducting, along with whether you’re a single member owner or in a partnership, is very important in considering before any incorporation.
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