S Corp vs LLC
Advantages and Disadvantages



S Corp vs LLC: Advantages and Disadvantages



S Corp vs LLC - The LLC is a relatively new type of hybrid business structure that is now permissible in most
states. It is designed to provide the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. Formation is more complex and formal than that of a general partnership.

The owners are members, and the duration of the LLC is usually determined when the organization papers are filed. The time limit can be continued if desired by a vote of the members at the time of expiration. LLC's must not have more than two of the four characteristics that define corporations: Limited liability to the extent of assets; continuity of life; centralization of management; and free transferability of ownership interests.


LLC Advantages Disadvantages

LLC Advantages

A limited liability company (LLC) has many advantages as a form of business entity:
  • Pass through taxation - under the default tax classification, profits taxed at the member level, not at the LLC level - no double taxation.


  • Limited liability - the members (owners) of the LLC, are protected from liability for acts and debts of the LLC.


  • An LLC can elect to be taxed as a sole proprietor, partnership, S-corp or corporation, providing the correct option for your business.


  • Can be set up with just one natural person involved or, in some states, one owner which may be an business itself.

  • No requirement of an annual general meeting for shareholders (in some states, such as Tennessee and Minnesota, this statement is not correct).


  • No loss of power to a board of directors (although an operating agreement may provide for centralization of management power in a board).


  • LLCs are enduring legal business entities, with lives that extend beyond the illness or even death of their owners, thus avoiding problematic business termination or sole proprietor death.


  • Much less administrative work and recordkeeping.


  • Membership interests of LLCs can be assigned, and the economic benefits of those interests can be separated and assigned, providing the assignee with the economic benefits of distributions of profits/losses (like a partnership), without transferring the title to the membership interest.

LLC Disadvantages

  • Earnings of most members of an LLC are generally subject to self-employment tax. By contrast, earnings of an S corporation, after paying a salary to the shareholders working in the LLC, can be passed through as distributions of profits and are not subject to self-employment taxes.


  • Since an LLC is considered a partnership for Federal income tax purposes, if 50% or more of the capital and profit interests are sold or exchanged within a 12-month period, the LLC will terminate for federal tax purposes.


  • If more than 35% of losses can be allocated to nonmanagers, the LLC may lose its ability to use the cash method of accounting.


  • An LLC which is treated as a partnership cannot take advantage of incentive stock options, engage in tax-free reorganizations, or issue Section 1244 stock.


  • There is a lack of uniformity among LLC statutes. Businesses that operate in more than one state may not receive consistent treatment.


  • In order to be treated as a partnership, an LLC must have at least two members. An S corp can have one shareholder. Although all states allow single member LLCs, the business is not permitted to elect partnership classification for federal tax purposes. The business files Schedule C as a sole proprietor unless it elects to file as a corporation.


  • Some states do not tax partnerships but do tax LLCs.


  • Minority discounts for estate planning purposes may be lower in a limited liability company than a corporation. Since LLCs are easier to dissolve, there is greater access to the business assets. Some experts believe that LLC discounts may only be 15% compared to 25% to 40% for a closely-held corporation.


  • Conversion of an existing business to LLC status could result in tax recognition on appreciated assets

S Corporation: To qualify, generally, the corporation must have a maximum of 75 shareholders who are individuals. Once a corporation makes the Subchapter S election to be an S-Corporation, profits and losses are passed through the corporation and are reported on the individual tax returns of the respective shareholders of the S-Corporation.

This is the same basic "pass-through" treatment afforded partnerships and LLCs. The key distinction of the S-Corporation is that profits and losses are not taxed at the corporate/business level like they would be if the corporation remained as a C Corporation.


S Corp vs LLC:
Advantages and Disadvantages

An LLC is not a separate tax entity like a corporation; it is what the IRS calls a pass through entity, like a partnership or sole proprietorship. All of the profits and losses of the LLC pass through the business to the LLC owners , who report this information on their personal tax returns. The LLC itself does not pay federal income taxes, but some states do charge the LLC itself a tax. Corporate Formalities



S Corp vs LLC:
Advantages and Disadvantages

An S-Corporation follows the same state formalities as does a C-corporation. However, an S-Corporation must make a special tax election under sub-chapter S of the Internal Revenue Code by filing IRS Form 2553.

Following the guidelines of the Corporate Formalities will help prevent Piercing the Corporate Veil.

S Corp vs LLC:
Advantages and Disadvantages

IRS Treatment

The S-Corporation must complete and file IRS Form 1120s to report its annual income to the IRS each year.

General Shareholder Requirements

ALL shareholders of the corporation must be U.S. Citizens or have U.S. Residency Status. If, for any reason, shares are somehow sold or transferred to a shareholder who is a foreign national, the corporation will lose its S-Corporation status and be treated as a C-Corporation.Losing S-Corporation Status

An S-Corporation that loses its status as such may not re-elect S-Corporation status for a minimum of five years.

Who should elect S-Corporation Status

Owners who want the limited liability of a corporation and the "pass-through" tax-treatment of a partnership will often make the S-Corporation election.


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