Limited Liability Company vs S-Corporation what should I pick?
Deciding between an Limited Liability Company and an S-Corporation is a question most entrepreneurs contemplate before starting a business. Both have limited liability protection and are pass-through entities that issue K-1’s to their owners and pay tax at the individual level. While they appear similar on the surface, they are totally different entity structures that should be used for different purposes.
When it comes to taxation, the major difference between an S-Corp and an LLC is the self-employment tax. The owners of LLC’s who engage in non-passive activities are subject to the 15.3% self-employment tax. S-corporations (and C-corporations) are NOT subject to self-employment tax. However, S-corporation owners are expected to draw a “reasonable” salary for their work. Only the amounts taken as a salary are subject to the 15.3% tax. What is considered“reasonable” is a grey area in the Internal Revenue Code and differs on the type of work.
The next major difference between an LLC and an S-Corp is the ownership requirements. S-corporations are far more restrictive than LLC’s. LLC’s can have unlimited members while an S-corp can have no more than 100 shareholders. Non-U.S.citizens and non-U.S. residents can be members of LLCs while S-corp status is reserved for U.S. citizens and residents. In addition, S-corporations are only allowed to be owned by individuals, certain trusts, and estates. Corporations, LLC’s or partnerships cannot own S-Corp shares while LLC’s are not limited in this capacity. S-Corp stock however, is freely transferable as long as these restrictions are met. An LLC membership interest is typically not transferable as the approval of other LLC members is required.
Another important distinction between LLC’s and S-Corps is the allocation of profits and losses. The shareholders of S-Corporations receive their profits based on their ownership percentage while LLC’s members can allocate profits and losses on any basis they seem fit.
To sum things up, LLCs and S-corporations are used for different purposes. Typically, business owners who are actively participating in their business opt for S-corporations to save on self-employment taxes. LLC’s are great for real estate investors who earn passive income and need to specially allocate their profits. Understanding the nature of your business and the requirements you seek in a partnership are the key to determining which entity structure is appropriate.
LLC & S-Corp
> Pass-Through Entities – Owners pay tax for their share of profits
> Limited Liability Protection
S-Corporation
> Stricter Ownership Requirements
> Stock Is Freely Transferable
> Not Subject to Self-Employment Tax – Shareholders expected to draw a reasonable salary
> Profits Received based on ownership percentage
> Higher Annual Fees
> Can only be owned by Individuals, certain trusts, and estates
Limited Liability Company
> Less Strict Ownership Requirements – Accessible to Non-U.S. Citizens and Residents
> Membership Interest not freely transferable
> Profits and Losses Can be Specially allocated
> Subject to Self-Employment tax on non-passive income
> Can be owned by corporations, partnerships, and other LLCs