When you’re starting a business, two of the most common structures you’ll encounter are the Limited Liability Company (LLC) and the S Corporation. They share some important features — both shield your personal assets from business debts and both allow profits and losses to flow through to your personal tax return. But the similarities largely stop there.

Here’s the key distinction most founders miss: an S Corporation is not a separate legal entity. It’s a tax election that an eligible LLC (or C Corporation) can make with the IRS. That means when you “form an S Corp,” what you’re actually doing is forming an LLC and then filing paperwork that tells the IRS to tax it like an S Corporation.

An LLC can have one or more owners — called “members” — including other LLCs, corporations, and even foreign entities. Most states impose no limit on the number of members. The notable exceptions: some states bar certain professions (doctors, lawyers, architects) from operating as standard LLCs, offering a Professional LLC (PLLC) as an alternative. A handful of industries — insurance and banking, for example — may also face restrictions.

Whatever the setup, every LLC should have a written Operating Agreement that documents each member’s ownership percentage, roles, and responsibilities. This isn’t just good practice; in many disputes, it’s the document that determines outcomes.

The IRS sets strict eligibility rules for S Corporation shareholders. Owners must be U.S. citizens or legal residents — no corporations, no partnerships, no non-resident aliens. The entity is capped at 100 shareholders and may issue only one class of stock. For a fast-growing startup that plans to raise multiple rounds of venture capital, these restrictions often make the S Corp election a poor fit.

Both structures put a legal wall between your personal assets — your home, savings, retirement accounts, vehicles — and the debts or lawsuits of the business. That protection is one of the primary reasons entrepreneurs form an LLC or corporation in the first place.

But the wall has gaps. Courts can “pierce the corporate veil” and hold owners personally liable if they:

The takeaway: forming the entity is step one. Maintaining it properly is what keeps the protection intact.

LLC members are not employees of their own company. They get paid by taking a “draw” — withdrawing money from their share of the company’s profits. In a single-member LLC, this typically means transferring funds from the business account to a personal account. In a multi-member LLC, draws are tracked in each member’s capital account, and most states give LLCs flexibility in how profits are divided (it doesn’t have to be proportional to ownership percentage).

If you do substantial work for your S Corporation, the IRS considers you an employee — and you must pay yourself a reasonable salary through the company payroll before you take any distributions. The company must register for payroll, withhold and remit income taxes, and pay FICA (Social Security and Medicare) on those wages.

Additional profits can then be distributed to shareholders in proportion to their ownership shares, and those distributions are not subject to self-employment taxes — which is where the potential tax savings come from.

Both structures avoid the “double taxation” that hits C Corporations (taxed at the corporate level, then again when profits are distributed to shareholders). But the mechanics differ in an important way.

A single-member LLC is treated as a sole proprietorship for federal tax purposes — all profits and losses flow directly to your personal return. A multi-member LLC is taxed as a partnership and files Form 1065, though income still passes through to individual returns. In both cases, all profits are subject to self-employment taxes (Social Security and Medicare, currently 15.3% on the first $168,600 of net earnings in 2024).

With an S Corp election, owners pay FICA only on their salary. Profit distributions beyond that salary are not subject to self-employment taxes. For a business generating strong profits above what constitutes a reasonable salary, this can represent meaningful annual savings — which is the main reason business owners make the election.

Both structures allow owners to borrow money or sell equity. An LLC can sell ownership interests according to the terms of its Operating Agreement. An S Corporation can issue stock — until it hits its 100-shareholder ceiling.

For businesses that expect to raise significant outside investment, especially from institutional investors like venture capital funds (which are typically structured as partnerships), the S Corporation’s ownership restrictions can become a hard blocker. A standard LLC or a C Corporation is generally more flexible for those growth paths.

Neither structure is fire-and-forget. LLCs — including those electing S Corp status — must stay current on their state’s compliance requirements. Common obligations include:

The exact steps vary by state, but the core process looks like this:

Once your LLC is formed, making the S Corp election is relatively straightforward — but timing matters.

File IRS Form 2553 (Election by a Small Business Corporation). New LLCs have 75 days from the date of formation to elect S Corp status for it to apply to that first tax year. Existing LLCs must file Form 2553 no more than two months and 15 days after the beginning of the tax year in which they want the election to take effect.

Some states also require a separate state-level S Corp election for the status to apply to state income taxes. Check your state’s requirements.

This article is for informational purposes only and does not constitute legal, tax, or financial advice. Consult a licensed attorney and tax advisor for guidance specific to your situation. CorpNet is a document filing service, not a law firm.