Understanding the difference between an LLC or S-Corp can be challenging for a small business owner. Neither is “better,” but when deciding, always consider your organization’s resources, mission, and plan for growth.
If you take one point away from this article, let it be this: a limited liability company is a business entity, registered with the Department of State. “S-Corp” status is a tax designation granted by the IRS, not a standalone business entity.
An LLC is the newest business structure, which allows for single- or multi-member ownership. It provides the limited liability of the traditional corporation, are relatively easy to run, and allows for pass-through taxation. This simply means the owners declare business profits on their personal income statements, and are taxed accordingly.
An S-Corp starts as a corporation*, which has received Subchapter S designation from the IRS. Traditionally, a corporation is “double-taxed,” meaning profits are taxed at the corporate level, and again at the shareholder level, usually in the form of dividends. With S-Corp status, a corporation’s profits are taxed once, on the shareholders’ personal income statements.
To be eligible for S-Corp status, a corporation must have fewer than 100 shareholders. Commonly, this leads people to believe the “S” stands for “small business.” This is technically incorrect, but is a good way to remember the difference!
S-Corp designation is obtained by filing IRS Form 2553 within 75 calendar days of the beginning of the entity’s tax year. Late filings are permitted, but you must provide a Reason for Late Filing, and approval is subject to the IRS’s discretion.
So what’s the difference?
There are several. First, an LLC has a “shelf life.” If one of the members dies or goes bankrupt, the entity dissolves. Second, owners of the LLC pay employment tax on the income of the entire business. That can add up to a lot of cash. Last, running an LLC is less complicated – fewer ongoing formalities, such as bylaws, annual meetings, &c.
An S-Corp allows for ownership to transfer over in the event of bankruptcy or death. Furthermore, only the wages paid are subject to employment tax, which can lead to tax savings for larger businesses. In addition to Form 2553, S-Corps have many of the ongoing formalities of a traditional corporation (C-Corp), and definitely more than an LLC.
On top of that, each state has ongoing requirements for both LLCs and S-Corps. Check with your state’s Corporations Division, or give us a call to determine your requirements.
What are my costs?
Filing Form 2553 costs nothing. However, the IRS estimates you’ll spend 16 hours researching and preparing the form. Furthermore, you’ll wait upwards of two months to receive notification, which could be a rejection.
Best of Both Worlds*
It is entirely possible to begin with the ownership structure of an LLC, and later requesting S-Corp tax status. By default, every limited liability company is taxed as a sole proprietorship or general partnership. As the business grows, you may choose to elect S-Corp taxation status. In this case, you still file Form 2553 within 75 calendar days of the beginning of the tax year. Legally, your business is still an LLC, but you are taxed as an S-Corp, whose ongoing formalities then apply.
Which makes sense for my business?
The major advantage of S-Corp status is tax savings for your business. The formula includes current revenue, your anticipated revenue in years to come, wage structure, and current tax rates. Speak with an accountant or your CFO/controller to decide what’s best for your business.
The second advantage is that you can obtain S-Corp status as either a corporation or LLC, and can file when it makes sense for your business. Be sure that filing is the right move, as the IRS cautions against changing your status more than once.
This concludes the second comparison in the series. As always, the decision is ultimately yours. With this information, and your knowledge of your business, you are better equipped to start!