Before 1800, nearly every business was either a sole proprietorship or a partnership. Either of these types did not have liability protection. Meaning, the owners of the business were responsible for all debts and actions against the business.
Wyoming state was the first to pass legislation allowing a new type of company called limited liability company.
That being said, a limited liability company (LLC) is a type of business structure that was created to offer small business owners liability protection, tax flexibility, and simplicity. The goal was to come up with a simple but more formal business structure than a sole proprietorship and partnership.
When Wyoming first passed legislation allowing an LLC, it was hardly noticed. However, the entity slowly grew in popularity, and more than two-thirds of new companies formed in the US are LLCs.
Before LLCs, there were corporations. General corporations were eligible for limited protection but the shareholders were subjected to corporate tax and could sometimes be taxed on their income from company benefits.
To curb the issue of double taxation, an S-corporation was established. S-corporation is a special type of corporation popular for its tax advantages. They are not subject to corporate income taxes, and therefore, there is not an “S-corporation tax rate.” Instead, the organization’s owners split the income or losses amongst themselves and pay individual taxes. Meaning, just like LLC, an S-corp is also a pass-through entity.
However, these two business structures are more different than they are similar. In this article, we will compare the two structures based on:
| Limited Liability Company | S Corp | |
| Pros | Allow an unlimited number of members Anyone can be a member. Offer more tax flexibility | Offer more liability protection Shareholders don’t pay self-employment. Easier to obtain outside funding. |
| Cons | Must file an annual report, and the fee can cost hundreds of dollars LLC members are subjected to self-employment taxation. | Cannot have more than 100 shareholders Must be a US corporation |
| Detail | Read Review | Read Review |
The main cost to form an LLC is filing the articles of organization with the secretary of state. The cost to file articles of organization varies from state to state but generally speaking, LLCs are cheaper to form and require less paperwork.
Other costs that you may incur include registered agent service, operating agreement and publication. However, it will depend on the service you choose and your state of formation. For instance, some states don’t require publication and some online formation services like ZenBusiness offer free registered agent service for one year.
Once formed, LLCs come with many benefits including liability protection, tax flexibility, unlimited number of ownership and much more.
An S-corp is just a corporation that has elected a special tax status with the IRS and therefore has the same paperwork as a general corporation. Meaning, for you to have your business taxed as an S-corp, you must form a standard corporation and switch to an S-corp if your corporation is eligible.
The main cost to form a corporation is filing the articles of a corporation which varies depending on the state of formation. Other costs you may incur include initial annual report, register agent service, business publication fees, and more. To change to an S-corp, you will have to complete IRS Form 2553 which will cost you additional charges.
However, S-corp offers more benefits than just tax advantages. Corporations generally have stronger personal liability protection than LLCs. Besides, this type of entity has been there for a long time and is therefore much familiar to financial institutions making it easier to get funding.
Limited liability company was born in Wyoming in 1977. Though its arrival was met by little to no applause, today the entity is by far the most popular choice for new businesses. Currently, not less than two-thirds of all new companies in the USA are LLCs.
A numerical study on the number of LLC, LP, and corporations formed in the US between 2004 – 2007 shows that LLCs are the new kings in the land. The study indicates that new LLCs were around 4.9 million compared to 3.3 million corporations and 199,393 new corps and LPs respectively.
An S Corp, also known as the subchapter or small business corporation, is a tax code that was enacted into law by Congress in 1958. This entity was created to encourage and support small and family businesses by eliminating the double taxation that the standard corporations were subjected to. Small businesses are the cornerstone of the American economy and therefore, it didn’t take long before S-corp became popular.
In just half a century after its formation, S-corp had become more popular than other types of corporations. According to IRS estimation, there are more than 5 million S-corporations in the US today. This is three times more than the number of corporations.
Ownership: An LLC can be formed by any individual, a corporation, another LLC, and more. LLCs are allowed to have an unlimited number of owners known as “members.” The members may be US citizens, non-US citizens, and non-US residents.
Liability protection: An LLC is a separate legal entity that offers liability protection. Meaning, in an event that your LLC faces bankruptcy or lawsuits, your personal assets such as your house, car, and savings account will not be used to repay the losses.
Taxation: An LLC has more tax flexibility than a corporation. Normally, it is treated as a pass-through entity – where profit and losses are passed through directly to individual tax returns. However, members of LLC are considered self-employed and will also pay self-employment tax towards social security and medicare. You can avoid this by opting to be taxed as other entities such as corporations.
Limited life: LLCs can have limited life in many states. That is to say, when a member leaves or joins, some states may require the LLC to be dissolved and reformed with new membership. However, if there is an agreement within the LLC for buying, selling and transfer of ownership, it doesn’t have to be dissolved.
Ownership: An S-corp is owned by not more than 100 shareholders. In addition, it can only have certain types of shareholders including individuals, certain tax-exempt organizations, certain estates, and trusts. S-corp must be a USA corporation- shareholders must be USA residents.
Liability protection: Being a corporation, it offers the strongest liability protection to its owners than LLCs.
Taxation: Though S-Corp is also treated as a pass-through entity, the shareholders are not subjected to self-employment taxation. S-corps shareholders are considered employees and don’t pay self-employment tax.
Independent lifetime: Unlike LLCs that have limited life in many states, S-corps have an independent life. Meaning, if a shareholder leaves the company or sells their shares, the S-corp can continue doing business undisturbed.
LLCs are not legally required to follow the same guideline as S-corps during formation and maintenance. For instance, they merely adopted LLC operating agreements instead of corporate bylaws for S-corporations. That said, forming an LLC is simple and straightforward.
The management structure is simple and the members are free to choose whether all the owners or a designated member run the business.
An S-corp is also simple to set up and operate but not as LLC. S-corp just like other corporations requires more extensive record-keeping, operational process, and reporting.
There are significant differences in terms of operational requirements. Among the many internal formalities requirements for an S-corp is strict regulation on adopting corporate laws. Others include annual shareholders meetings, extensive regulations related to issuing stock shares, keeping and retaining company meeting minutes.
In addition, S-corps are required to have a board of directors and corporate officers. The board of directors oversees the management and is in charge of major corporate decisions. S-corps also have corporate officers such as the chief executive and the chief financial officer who manage the day-to-day company operation.
LLC is a standard business formation service known for its simplicity and tax flexibility. For that reason, it is the most popular among small business owners.
To form a business with an LLC, you only need to file articles of organization with the secretary of state during which you’ll submit a state filing fee along with the form.
Other important documents for LLC formation are an operating agreement, a Federal Tax ID, and a registered agent service.
Corporations are formed by filing articles of the corporation with the secretary of state. The paperwork involved in forming an S-corp is quite a lot. The paperwork and the requirement to form corporations are quite demanding. You will have to appoint a board of directors, write corporate bylaws, draft a shareholder agreement, and hold an initial board meeting when forming a corporation.
To charge your standard corporation to an S-corp, you will proceed to file IRS S-corp tax election form 2553. There are restrictions involved and not all businesses qualify to fill this form.
Every LLC formed in the US must appoint and maintain a register in its formation state and every state it qualifies to do business as a foreign LLC. A registered agent is res[ponsiple for receiving vital information on behalf of the company and submitting them to you. A registered agent can be an individual or a business entity.
S-corps are also required to appoint and maintain registered agents in the formation states and every state where your business qualifies to operate as a foreign LLC. The cost of a registered agent will depend on whom you choose as your agent. Given that maintaining an S-corporation is more demanding than an LLC, we may be right to conclude that a registered agent service for a corporation may demand more fees than an LLC.
LLCs require little paperwork. An LLC is simply formed by filing an article of organization and submitting state filing fees. That said, depending on your business requirement, state of formation, and the service you opt for, you may create an LLC within 1 business day to several weeks.
Being a type of corporation, an S-corp starts from forming a corporation. Forming a corporation requires more paperwork than forming an LLC. In addition to filing the articles of the corporation along with the state filing fees, you will have to file an initial annual report, create management bylaws, and undertake other administrative work. Once you have formed a corporation, you will have to file IRS S-corp election form 2553.
Processing all these documents will obviously take longer than processing LLC formation documents. That said, it may take several weeks to have your paperwork processed. But some states offer expedited filing that may reduce the waiting time by 10 business days.
There is no single choice that is always better for you. The best option will depend on your business needs.
You are a small business looking for a standard business formation entity that is easy to set up and operate.
You want to avoid self-employment taxations and require stronger liability protection.
While LLC is a business entity, S-corp is merely a special tax election. For that reason, if you are looking for a standard business formation entity between these two, LLC is far much better. The main advantage of an S-corp over an LLC is its tax benefits. The good news is, you can have your LLC taxed as S-corp and enjoy the benefits.
Our LLC vs corporation comparison has been crafted to help you decide on the best entity to incorporate your business without the hassle. LLC is great for small business owners who want flexibility without a lot of corporate formality. On the other hand, small and large owner-managed businesses seeking outside investments should pick corporations.
As always, we recommend you take your time and consideration before you make your decision. Once you arrive at your decision, feel free to share with us the experience with your pick.
LLC is a standard business formation entity that offers a lot of benefits. S-corp is a tax election with a lot of restrictions. For that reason, LLC will be the best to form a business. Furthermore, you can have your LLC taxed as S-corp and enjoy the taxation benefits.
LLC’s main advantage is that it is a simple structure that requires little paperwork. S-corp comes with the advantage of tax benefits- it is not subjected to corporation double taxation and LLC self-employment taxation.
S-corp shareholders are employees and therefore don’t pay self-employment tax. This is the main reason most LLC members elect to be taxed as S-corp – to avoid LLC self-employment tax.
An LLC is not a type of corporation, but rather a unique hybrid entity that combines the simplicity of sole proprietorship and liability protection of a corporation.
An S-corp is ideal for more complex companies since there is a need to create a board of directors and many regulatory requirements. That said, a single-operated LLC cannot change to S-corp. However, you can file a tax form to have your LLC taxed as a corporation.
