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S Corporations and LLCs are both popular business entity choices for a closely held business or solopreneur. Both business structures offer their owners pass-through taxation and limited liability.
Deciding whether an LLC or S Corporation is best for you will depend on your unique situation, preferences, and business needs.
S Corporations and LLCs are similar in some respects, but different in others. One business entity may be a better option than the other depending on what is important to your business.
CT Tip: LLCs are generally more flexible than S Corporations, which have strict requirements on proportionality of distributions of income and loss.
However, unlike LLCs, S Corp dividend income isn’t subject to self-employment tax.
Below are some considerations to hopefully help when you’re deciding which business entity is best for you.
An LLC and an S Corp are each separate business entities formed with a state. Each has a Registered Agent, files annual reports, maintains good standing with states, complies with business license requirements, and so forth.
And, both LLCs and S Corporations offer their owners limited liability protection. However, LLCs may offer stronger protection in some cases than an S Corp.
An S Corporation is a corporation that qualifies for pass-through tax treatment from the IRS. This makes the S Corp different from a C Corp, which is subject to “double-taxation” on dividends.
But, to get S Corp tax status from the IRS, owners have to comply with strict IRS tax rules on types of S Corp shareholders and stock and on proportionality of distributions.
And remember: S Corps are corporations, even though they are taxed differently than regular corporations. They need to follow the same formalities as other corporations and they need to have directors, officers and shareholders.
A popular benefit of the S Corporation is that owners can enjoy a combination of salary-and-dividend income and the S Corp dividends are not subject to self-employment tax. Also, some business owners prefer S Corps over LLCs because the stricter S Corp requirements tend to “keep things simpler” – although they do add the burden of checking with your advisor to ensure you’re keeping up with those requirements over time. And, some investors prefer the corporate form over the LLC.
CT Tip: If you might convert to a C Corp later, it’s much simpler to do so if you’re an S corporation instead of an LLC.
You may like the S corporation business structure if:
LLCs also receive pass-through tax treatment from the IRS. In fact, an LLC automatically receives pass-through tax treatment unless an IRS election is made otherwise.
CT Tip: If you own 100% of your LLC, business income is taxed on your individual income tax return as if you were a sole proprietor.
Compared to S Corporations, LLCs offer a great amount of flexibility in management and avoid corporate formalities. However, some investors prefer corporations over LLCs, because corporations are generally better for recapitalizing and reorganizing over time as a business grows.
You may like the LLC business structure if:
As you can see, the LLC and S Corp do have some similarities and differences – all of which may come into play when choosing a business form and deciding the one that’s best for you.