LLC vs S Corp: Which is better for a small business?

When choosing a business structure, many entrepreneurs compare an LLC (Limited Liability Company) and an S Corporation. It’s important to understand that these two are not the same kind of thing: an LLC is a legal business entity, whereas an S Corp is actually a tax classification​. In fact, an LLC can elect to be taxed as an S Corp. Here’s a breakdown of their differences and how to decide:

• Formation and Structure: An LLC is simpler to form and has a flexible management structure. It can have one owner (single-member) or multiple owners (members), and it doesn’t require a board of directors or formal meetings. An S Corp begins as either a corporation or LLC that files for S Corp status with the IRS. If starting from scratch, forming a corporation and then electing S Corp status involves more paperwork/formalities (issuing stock, adopting bylaws, holding shareholder meetings).
• Liability Protection: Both LLCs and S Corps offer limited liability, meaning the owners’ personal assets are generally protected from business debts or lawsuits. In this regard, one is not “better” than the other – both structures shield your personal assets as long as you operate the business properly.
• Taxation: By default, an LLC has pass-through taxation – profits (or losses) pass through to the owner’s personal tax return, and there’s no corporate tax. An S Corp is also generally taxed as a pass-through (no double taxation of corporate profits), but with a twist: S Corp owners who work in the business are usually required to take a salary, and remaining profits can be treated as distributions. The advantage is that distributions (after a “reasonable salary”) are not subject to self-employment tax, potentially saving the owner money. In other words, an S Corp can provide tax savings on Social Security/Medicare taxes if the business’s profits are high enough​. LLC owners, by contrast, pay self-employment tax on all profits unless they elect S Corp taxation.
• Ownership restrictions: LLCs have very few ownership restrictions – even other corporations or foreign individuals can be members. An S Corp, however, has strict IRS rules: it can’t have more than 100 shareholders, shareholders must generally be U.S. citizens or residents, and it can only issue one class of stock. These restrictions mean S Corp status might not be available or ideal for certain businesses (for example, a startup planning to raise venture capital or have non-US owners would not use an S Corp).
• Ongoing requirements: LLCs typically have lighter ongoing requirements – depending on your state, you might just file an annual report and pay a fee. S Corps (being corporations for legal purposes) have to follow corporate formalities: hold annual shareholder meetings, keep meeting minutes, and file additional federal tax forms (like an 1120-S tax return). Failing to adhere to these can risk your status.
• Which is better for you? It depends on your situation. If you’re a solo or small business starting out and want flexibility and simplicity, an LLC is often a great choice due to easy setup and minimal red tape. On the other hand, if your business is earning enough profit that the self-employment tax savings of an S Corp outweigh the extra paperwork (many CPAs suggest this becomes beneficial around $40,000+ in annual profit, though it varies), then electing S Corp status could save you money. Some entrepreneurs start as an LLC and later convert to an S Corp when profits increase.

In summary, neither is inherently “better” universally – LLC vs S Corp is about trade-offs. The LLC offers simplicity and flexibility; the S Corp offers potential tax advantages and a more defined corporate structure but with more rules. Many small businesses are LLCs by default and only pursue S Corp status if there’s a clear tax benefit. It’s wise to consult with a tax professional about your specific circumstances.