Difference between S corp and LLC

As we said, an LLC is a legal business structure, whereas an S corp is a tax filing status. But let’s compare a standard LLC to an LLC with S corp election. First, we’ll examine the advantages an LLC with S corporation election has over an LLC without S corporation election.

Advantages of S Corp Over LLC

As we just explained, the members of a standard LLC can’t be employed by the business. The money they make from the LLC comes from distributions, a.k.a. their share of the profits. They must then pay 15.3% in self-employment tax on all those profits. If the LLC is particularly profitable, that can add up to a sizeable chunk of change.

An LLC with S corporation election can pay its members in two ways, in distributions and a salary from the LLC. In that case, the members would only pay employment taxes (Social Security and Medicare) on their salary from the LLC, but not on the distributions. Again, in a more profitable business, the tax savings can add up. Money paid out as salary is also a tax-deductible expense for the business. 

Advantages of LLC over S Corp

Traditional limited liability companies also have some advantages over those with S-corp election:

Requirements for S Corporations

The Internal Revenue Service (IRS) has stricter requirements for businesses with S corp designation. For an LLC or corporation to qualify for S corporation election, the Internal Revenue Code says they must:

• Be a domestic corporation or LLC
• Have no more than 100 shareholders or members 
• Have only allowable shareholders or members, which includes individuals, certain trusts, and estates. The shareholders may not be partnerships, corporations, or non-resident aliens. A nonresident alien is an alien who has not passed the green card test or the substantial presence test.
• Not be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations
• Have only one class of stock

As you can see, these restrictions would limit the number and type of members an LLC set up as an S corporation could have. A traditional LLC could have more than 100 members and be owned by corporations, partnerships, and non-resident aliens.

More IRS Scrutiny

Remember what we said about LLC members being required to pay themselves a “reasonable salary”? The IRS watches this closely to prevent abuse. If your salary is inadequate, you’re not contributing enough to Social Security and Medicare.

That’s why the IRS expects you to pay yourself a reasonable salary. But how does the IRS define “reasonable compensation”? The instructions on Form 1120-S read, “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.”

While those instructions don’t provide a 100% clear definition, the IRS seems to consider “reasonable” to be something similar to what others in your field are earning for the same work.

All of this means that a business with S corp designation is more likely to be audited than one without. And, if the IRS decides that your salary is not reasonable, it has the authority to reclassify your non-wage distributions (which are not subject to employment tax) to wages (which are subject to employment tax). Several court cases have supported the IRS’s right to do this.

Additional Accounting and Bookkeeping

Having an LLC filing as an S corporation generally means more paperwork. If you don’t already have to do payroll and calculate payroll taxes for your business, being an owner-employee means that you’ll have to do so. Your taxes will be more complex, as well.

With these added complications, you’re likely to have higher administrative costs. You may find that you need an accountant, bookkeeper, and/or a payroll service or software.

How We Can Help

Now that you understand the difference between LLC and S corp, you’ll have to weigh all the factors to see which choice best fits you and your business. We don’t recommend doing this alone, though. It’s times like these when you need a skilled tax professional to help you make an informed decision.

If you’re planning to start an LLC, with or without the S corp designation, we can handle the process for you. Our LLC formation service sets you up with experts who can file the paperwork with the state for you. And, if you’d like to form your LLC as an S corp, our S corporation service can take care of that added step, too. Once you’re established, we have other services like Worry-Free Compliance to help you stay compliant with government regulations.

You can do this. We can help.

Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.