Whether you’re starting a new business or thinking of changing an existing business’s structure, you’re likely familiar with the terms “LLC” and “S corporation.” These are the two most common business entities in the U.S., and most entrepreneurs end up choosing between them. And as similar as they are, these entities have several things that set them apart.
Want to ensure you’ll pick the right structure for your business? Read on to learn more about these two business entities and how to decide on the right one for your needs.
What Is an LLC?
LLC is shorthand for “limited liability company.” This form of business entity combines the flexibility and tax benefits of a partnership with the limited liability protection of a corporation.
Forming an LLC means establishing the business as a legal entity separate from its owner(s). This means that the owner(s), who are called member(s), aren’t personally responsible for the obligations or debts of their business.
An LLC can also be taxed as a pass-through entity, where profits and losses get passed through to the owner’s or owners’ personal tax returns. Alternatively, you can choose to be taxed as a corporation. If a single-member LLC does not elect to be treated as a corporation, the LLC is considered a “disregarded entity,” and the LLC’s activities should be reflected on its owner’s federal tax return either through Schedule C, Schedule E, or Schedule F.
What Is an S corporation?
An S corporation (S corp) is a business structure that’s usually a good fit for small and medium businesses looking to avoid double taxation.
In an S corp, the income and deductions pass through to the personal tax returns of its shareholders. The business itself isn’t subject to federal income tax. As a result, an S corporation’s shareholders are only taxed once for their company’s profits.
A business needs to meet specific requirements to be eligible for S corp status. These include being organized as a domestic corporation and having no more than 100 shareholders.
Which Option Is Better for You?
If you have plans to scale your business in the near future, an S corp will likely be the better option. S corps make it easier to contribute to retirement funds and position your company for growth. They also require additional payroll systems and tax forms, both of which could prove overwhelming for businesses that are already struggling to make a profit.
Establishing an LLC makes sense if you want to minimize upkeep but are still concerned about personal liability. In general, legal requirements related to LLCs tend to be more lax than business upkeep requirements for corporations.
Keep in mind that an LLC can be an S corp as well. If your LLC is starting to bring in serious profit, you may want to reclassify to an S corp to avoid paying a self-employment tax.