LLC vs. S Corp

When choosing a business form, business owners often end up deciding between an S corporation and LLC.  As this article explains, limited liability companies and s corporations share both similarities and differences, which can vary by state. Ultimately, you should talk to your advisor, but here are some things to keep in mind as you consider your option.

LLCs and S Corps Both Provide Limited Liability

Both LLCs and S corporations offer their owners limited liability protection. If you run your business as a sole proprietor, then business creditors can reach any of your assets, even if those assets have absolutely nothing to do with the business. Forming an LLC or S Corp greatly limits your liability. This is especially helpful if there’s ever an unexpected event, or if you ever hire employees.

LLCs and S Corps Both Offer Pass-through Taxation

When it comes to federal income taxation, S Corps and LLCs both offer their owners pass-through taxation. This means that business income and losses are not taxed at the company-level, but “pass-through” to the owners and are reported on the individual’s tax returns. This avoids the “double taxation” imposed on C Corporation dividends that are taxed at two levels: the corporation and shareholders.

But, LLCs and S corps are each governed by very different federal income tax rules and file different tax returns, as discussed below. LLC’s generally more flexible than S Corporations, which have strict requirements on proportionality of distributions of income and loss.

Advantages of LLCs over S Corporations

Flexibility in management and allocation of income and losses are among the advantages of an LLC over an S Corp. For example, an LLC does not have as many state-mandated requirements regarding meetings and an LLC’s owners are free to determine whether the company will be member-managed or manager-managed. In contrast, an S corporation generally must observe all corporate formalities regarding shareholder and director meetings and issuance of stock. Also, LLC owners have fairly wide discretion in the terms of the LLC Operating Agreement that governs the relationships of the business and its owners.

The IRS rules governing LLCs generally offer their owners far greater flexibility than S corporations. Owners of LLCs can allocate profits and losses disproportionately among owners; an S corporation’s profits and losses must be allocated strictly based upon ownership percentage. If multiple LLC owners have different roles in the business, this could be especially beneficial.

For business owners who own 100% of their business, LLCs also offer the advantage of being able to include your business income and loss on your Form 1040 individual federal income tax return.  This option disappears if the LLC has more than one owner. LLCs with more than one owner are taxed as partnerships and a separate partnership return has to be filed with the IRS.

LLCs also offer more income tax choices in how you are taxed. By default, LLCs enjoy pass-through taxation under IRS rules. However, by making an IRS election, you could have your LLC taxed as an S Corporation. A strong caveat here – which you should discuss with your tax advisor – is that if an LLC elects S Corp taxation, it still has to satisfy all the S Corp tax rules and states differ in how they treat the IRS election. But, if all requirements are met, LLCs owners can enjoy the best of both worlds so to speak by electing S corporation federal taxation.

Disadvantages of LLCs vs S Corps

Although they offer many advantages, LLCs do have some drawbacks. If you plan to go public or will be seeking venture capital or angel funding, the corporation may be a better choice. Many investors prefer the corporate form over an LLC.

LLC owners pay self-employment taxes, which can result in a higher overall tax liability versus an S corporation that can pay both salary and dividends, which are not subject to self-employment taxes. However, as noted above, an LLC can elect to be taxed as an S corporation, which enables its owners to receive both salary and dividend income.

Advantages of S Corps over LLCs

The principle advantage offered by an S corporation is the ability to receive both salary and dividends, which could lower the overall tax bill.

CT Tip: The salary must be “reasonable” according to the IRS (and the IRS watches this closely).

Another advantage is ease of conversion to a C corporation. It is generally much easier to convert from an S corp to a Corp than it is to convert from an LLC to a C Corp. This can be important if you anticipate raising capital by selling shares of stock or by going public.  Venture capitalists generally prefer taking stock over LLC membership shared.

Disadvantages of S Corps vs. LLCs

Owners of an S Corp face greater restrictions than do the owners of an LLC regarding their management structure and profit/loss allocations.  Plus, the IRS imposes strict rules in order to obtain, and maintain, S corporation status.  In order to make the election, the corporation:

  • Can have only certain types of shareholders (e.g., individuals, certain estates and trusts, certain tax-exempt organizations)
  • Cannot have more than 100 shareholders
  • Must be a U.S. corporation
  • Can have only one class of stock (but differences in voting rights are permitted)

The IRS restrictions never end. At any time, violating these rules will jeopardize your pass-through taxation.


As you can see, both the LLC and the S Corp have their advantages and disadvantages.

You may prefer an S corp if:

  • You want to have earnings distributed proportionately to capital contributions 
  • You want to earn a salary instead of self-employment income
  • You want ease of obtaining investment capital
  • You want pass-through taxation
  • You may want to be a C Corp later

On the other hand, an LLC might be your choice if:

  • You want the maximum flexibility in running your company
  • You want to allocate profits and losses based upon criteria other than ownership percentage
  • You prefer to avoid the state-mandated meeting requirements imposed on corporations
  • You don’t foresee raising capital by selling ownership stakes to many investors or by going public
  • Pass-through taxation is important to you

Between an llc and an s corporation, there is no single choice that is always better for every business owner.  Instead, there are better options based upon you current needs and future plans.  Working with a business professional is the best way to determine which is best for you: LLC or S Corp.

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