Choosing between an S Corporation (S Corp) and a Limited Liability Company (LLC) is one of the most important decisions business owners make. Both structures offer liability protection and tax advantages, but they operate differently in key areas such as taxation, ownership rules, and administrative requirements.

This article breaks down the similarities and differences so you can determine which structure may best fit your business goals.

What Is an LLC?

A Limited Liability Company (LLC) is a flexible business structure created under state law. It provides limited liability protection to its owners (called “members”) while allowing flexibility in taxation and management.

By default:

• A single-member LLC is taxed as a sole proprietorship.
• A multi-member LLC is taxed as a partnership.

However, an LLC can elect to be taxed as a corporation — including as an S Corporation — by filing the appropriate election with the IRS.

What Is an S Corporation?

An S Corporation (S Corp) is not a business entity type created by state law. It is a tax classification under Subchapter S of the Internal Revenue Code.

To become an S Corp:

1. You first form a corporation (or an LLC).
2. Then you file Form 2553 with the IRS to elect S Corporation status.

An S Corp allows profits and losses to pass through to shareholders while potentially reducing self-employment taxes for owner-employees.

Key Similarities Between an LLC and an S Corp

1. Limited Liability Protection

Both structures protect the personal assets of the owners. Generally, owners are not personally responsible for business debts or lawsuits.

2. Pass-Through Taxation

Both structures avoid double taxation (in most cases). Income passes through to the owners and is reported on their individual tax returns.

3. Separate Legal Entity

Both create a legal separation between the business and the owner(s), as long as corporate formalities and proper recordkeeping are maintained.

4. Flexibility for Small Businesses

Both are commonly used by small and mid-sized businesses seeking liability protection and tax efficiency.

Major Differences Between an LLC and an S Corp

1. Tax Treatment

LLC (Default Taxation)

• Profits are subject to self-employment tax (15.3% on net earnings).
• All net profit is typically subject to Social Security and Medicare taxes.

S Corporation

• Owner must take a reasonable salary (subject to payroll taxes).
• Remaining profits can be distributed as dividends.
• Distributions are not subject to self-employment tax, which may reduce overall tax liability.

Example:
If a business nets $100,000:

• LLC: Potentially all $100,000 subject to self-employment tax.
• S Corp: Salary portion taxed as payroll; remaining profit may avoid self-employment tax.

This is often the main reason businesses elect S Corp status.

2. Ownership Restrictions

LLC

• Unlimited number of members.
• Members can be individuals, corporations, partnerships, or foreign persons.
• Flexible ownership structure.

S Corporation

• Maximum of 100 shareholders.
• Shareholders must be U.S. citizens or residents.
• Only one class of stock allowed.
• Cannot be owned by partnerships or corporations.

S Corps have stricter eligibility requirements.

3. Administrative Requirements

LLC

• Generally fewer formalities.
• No requirement for annual shareholder meetings (depending on state).
• Flexible management structure.

S Corporation

• Must follow corporate formalities:
  • Board of directors
  • Officers
  • Annual meetings
  • Corporate minutes
• Payroll must be processed for owner-employees.

S Corps involve more compliance and recordkeeping.

4. Profit Distribution Flexibility

LLC

• Profits can be distributed disproportionately (if allowed in the operating agreement).
• Very flexible allocation of profits and losses.

S Corporation

• Profits must be distributed based strictly on ownership percentage.
• No special allocations allowed.

5. Raising Capital

LLC

• Easier to structure flexible ownership agreements.
• Can have multiple membership classes (depending on structure).

S Corporation

• Limited to one class of stock.
• More restrictive when bringing in investors.

When an LLC Might Be Better

An LLC may be ideal if:

• You want maximum flexibility.
• You have foreign investors.
• You want fewer administrative requirements.
• You are just starting and profits are relatively low.
• You want flexible profit distributions.

When an S Corporation Might Be Better

An S Corp election may be beneficial if:

• The business generates consistent net profit (often $50,000+).
• The owner wants to reduce self-employment taxes.
• The business can support paying the owner a reasonable salary.
• The ownership structure meets IRS eligibility rules.

Important Consideration: LLC Can Elect S Corp Status

Many business owners form an LLC for legal flexibility and then elect S Corporation taxation for tax savings.

This hybrid approach provides:

• State-level flexibility (LLC structure)
• Federal tax savings (S Corp election)

Final Thoughts

Both an LLC and an S Corporation provide strong liability protection and pass-through taxation, but they differ significantly in tax treatment, ownership rules, and administrative requirements.

The right choice depends on:

• Profit level
• Long-term growth goals
• Ownership structure
• Administrative capacity
• Tax strategy

For tax professionals and business owners, analyzing projected income and compliance costs is critical before making the election.

When structured properly, either entity can be a powerful tool for building and protecting wealth.