LLC vs. S-Corp: The differences between them

What Is an LLC?

The LLC is a business format that is very popular with start-ups as it offers a number of benefits. It provides personal liability, which implies that personal possessions of the owners are usually secure in case the company is sued or is unable to cover the debts. LLC is also a pass through entity to taxation meaning that the company does not pay taxes directly.

Rather, the members are subject to the flow of profits and losses to them, which are reported on their individual tax returns. The LLCs also offer important flexibility to the management, and there are very few formal requirements on the way the business is to be operated.

What Is a Corporation?

A company is even more complicated than LLC and is associated with more rigid legal regulations. The shareholders own the corporations and have the benefits of the companies profits but the debts of the company do not affect the shareholder themselves. Corporation is managed in a formal way with the help of a board of directors that takes care of strategic management and planning of the business.

There are also laws which corporations are required to follow such as annual meetings, officers, and keeping of corporate records in detail. In contrast to LLCs, corporations are taxed on their profit, and shareholders are also taxed on the dividends they get, and this is the reason why there is a double taxation.

LLC vs. S-Corp: Key Differences

Ownership

• LLC: The owners are referred to as members. The operating agreement spells out the percentage ownership, share of profits, duties and process of changing ownership of each member.
• S-Corp: It is a shareholder corporation with owners being shareholders, and ownership according to number of shares. The dividends are paid to the shareholders on a pro rata basis. Corporations are also appealing to investors as the shares can be transferred easily.

Administration

Compared to corporations, LLCs are normally simpler and cheap to form. They do not need a board of directors or to conduct formal annual meetings, but usually annual reports are required to be given in many states. Corporations are more complicated and they need hierarchy of government and accounting.

Control

The members of LLC can do everything, and structure their management. On the contrary, corporate managers are answerable to the board of directors, which has the final authority to make decisions.

Limited Personal Liability

LLCs as well as S-Corps have liability protection. Owners do not form part of the business, however they can be liable in case they assure loans personally, commit fraud, or breach operating agreements or corporate bylaws.

Taxes

LLC:

• The single-member LLCs are taxed like the sole proprietorships; The multi-member LLCs are taxed like partnerships.
• Members are taxed as self-employed except in case they choose S-Corp or C-Corp.
• LLCs have an option of choosing corporate taxation by filling IRS Form 8832 (C-Corp) or Form 2553 (S-Corp).

S-Corp:

• Pass-through taxation evades corporate taxes.
• The shareholders can be considered employees and receive salaries, which lower self-employment taxes.
• On top of that, it demands extra payroll and accounting which can only be economical in a situation where tax savings outweigh the expense.

Profit Sharing

• LLC: It is flexible in profit allocation since it may be customized in the operating agreement. The input or the responsibilities of one member can lead to the allocation of more than the share of ownership.
• S-Corp: The profits are allocated based on share ownership, which does not provide much flexibility as LLCs do.

Choosing the Right Entity

The LLC is frequently a good choice of a small company or an individual owner who wants to be simple and secure. S-Corps would be more suitable in case companies expect to raise investment funds or prefer to pay less in self-employment taxes but satisfy the more formal corporate requirements.

Can a Corporation Own an LLC?

LLCs may be owned by corporations which are typically a holding company with several subsidiaries under it. A holding company:

• Remains in charge of subsidiaries without interfering with operations.
• Is able to finance subsidiaries and get profits.
• Brings security to the economy through dividing liabilities between businesses.

In addition, a corporation can also buy or purchase the controlling interested in an LLC and thus turn it into a corporate owned entity.

Member Corporation taxation

LLCs are pass through entities. When a corporation is the owner of a LLC its income is considered to be corporate income and it is taxed like a corporation. Dividends are also taxation to shareholders. A large number of holding companies choose LLC to escape a double tax.

The Corporations that are not allowed to own an LLC

Some cases in which corporations cannot own LLCs are:

• Insurance companies or banks are not allowed to be the members of LLC.
• PLLCs are required to have state-licensed professionals as owners, including doctors or lawyers, and may not include corporate members.

Converting LLC to S-Corporation

To elect S-Corp taxation:

• File Form 2553 with the IRS.
• The filing should not be later than two months and fifteen days following the commencement of the tax year or at all preceding the year of election is to be effected.

Modifications Following Election of S-Corp

• Ownership restrictions: 100 shareholders maximum; all shareholders must be U.S citizens or residents.
• Management requirements: Has to have a board, have a meeting every year, maintain minutes, and appoint corporate officers including the CEO and the CFO.

Can an LLC Own an S-Corp?

• S-Corps can be owned by single-member LLCs.
• Multi-member LLCs are not possible because they are by default taxed as partnerships.

The IRS imposes a limitation on the ownership of an S-Corp to guarantee the application of the pass-through taxation rightly and to avoid tax evasion.

Purchasing an S-Corp

In case an LLC is not allowed to be the owner of an S-Corp and wishes to purchase one, the purchase is to be made personally. Both parties enjoy liability coverage and pass through taxation.