Difference between LLC and S Corp for tax purposes?

For federal income tax purposes, there is no such thing as being taxed as an LLC or Sub S. Both are treated by the IRS as pass-through entities which are business entities in which income is passed through to its owners and taxed at their personal tax rate. This method allows businesses to avoid double taxation and potentially reduce their overall taxes owed. However, a single-member LLC is taxed as a sole proprietor and will incur additional payroll tax, unlike Sub S. An LLC is not a corporation, it’s a partnership. Talk to an Accountant before you decide.

So what is the difference between LLC and S Corp? Many small businesses are structured as limited liability companies (LLCs) not fully understanding the difference between LLC and S Corp For Tax Purposes. If you are just starting into business and looking at business types, you may find the difference between an LLC and an S corporation confusing. The two business types are similar, but they do have some essential differences. We will look at the structure of the two business types, how the businesses report tax liability, and how the owners of these businesses pay taxes.

What is the difference between LLC and s corp?

A business structure, in terms of the legal entity you choose for your business, significantly impacts some important issues in your business life. These issues include the liability exposure, and at what rate and manner you and your business are taxed. Your choice of corporate structure can also substantially affect issues such as financing and growing the business, the number of shareholders the business has, and the general manner in which the business is operated. You should be aware of some of the differences in business formation, especially when choosing between an LLC or S corporation for your business.

The difference between LLC and S Corp For Tax Purposes surged to the forefront around the time of the Small Business Job Protection Act of 1996, which contained several changes to basic corporate tax law, such as enabling S corporations to hold any percentage of stock in C corporations. C corporations, however, are not allowed to own stock in S corporations.

Limited Liability Companies

The choices of limited liability companies (LLCs) and S corporations are increasingly popular due to their basic benefits of liability protection and pass-through taxation. LLCs protect the owners’ personal assets from losses, company debts, or court rulings against the company. LLCs also avoid the double taxation to which C corporations are subject to because they pass all company income through to the tax returns of the individual owners.

Ownership of an LLC

An LLC is allowed to have an unlimited number of owners, commonly referred to as “members.” These owners may be U.S. citizens, non-U.S. citizens, and non-U.S. residents. Also, LLCs may be owned by any other type of corporate entity. Further, an LLC also faces substantially less regulation regarding the formation of subsidiaries.

LLC Business Operations

The difference between LLC and S Corp For Tax Purposes as well as business operations are much simpler, and the requirements are minimal. While LLCs are urged to follow the same guidelines, as the S corporations, they are not legally required to do so. Some of these guidelines include adopting bylaws and conducting annual meetings.

For example, instead of the detailed requirements for corporate bylaws for S corporations, LLCs merely adopt an LLC operating agreement, the terms of which can be extremely flexible, allowing the owners to set up the business to operate in whatever fashion they most prefer. LLCs are not required to keep and maintain records of company meetings and decisions in the way that S corporations are required to do.

Management Structure of an LLC

The owners/members of an LLC are free to choose whether owners or designated managers run the business. If the LLC elects to have the owners occupy the company management positions, then the business operates more closely resembling a partnership.

S Corporations

An S corporation’s structure also protects business owners’ personal assets from any corporate liability and passes through income, usually in the form of dividends, to avoid double corporate and personal taxation. However, while both options offer these basic benefits in one form or another, there are significant distinctions between them that require careful consideration when establishing a business entity.

Ownership of an S Corporation

The IRS is more restrictive regarding ownership for S corporations. These businesses are not allowed to have more than 100 principal shareholders or owners. S corporations cannot be owned by individuals who are not U.S. citizens or permanent residents. Further, the S corporation cannot be owned by any other corporate entity. This limitation includes ownership by other S corporations, C corporations, LLCs, business partnerships, or sole proprietorships.

S Corporation Business Operations

There are significant legal differences in terms of formal operational requirements, with S corporations being much more rigidly structured. The numerous internal formalities required for S corporations include strict regulations on adopting corporate bylaws, conducting initial and annual shareholders meetings, keeping and retaining company meeting minutes, and extensive regulations related to issuing stock shares.

Further, an S Corporation may use either accrual or cash basis account practices.

Management Structure of S Corporations

In contrast, S corporations are required to have a board of directors and corporate officers. The board of directors oversees the management and is in charge of major corporate decisions, while the corporate officers, such as the chief executive officer (CEO) and chief financial officer (CFO), manage the company’s business operations on a day-to-day basis.

Other differences between LLC and S Corp For Tax Purposes include the fact that an S corporation’s existence, once established, is usually perpetual, while this is not typically the case with an LLC, where events such as the departure of a member/owner may result in the dissolution of the LLC.

Qualified Business Income Deduction

LLC members and S corporation shareholders may be eligible for a qualified business income (QBi) deduction for tax years beginning in 2018. This deduction allows a deduction of up to 20% of their qualified business income, in addition to standard business deductions.

Limitations on Business Losses

Business owners who don’t materially participate in their businesses may not be able to claim all losses on their tax returns. Owners of LLCs and S corporations are both subject to passive loss limitation rules.

Making the Right Choice

LLCs are easier and less expensive to set up, and simpler to maintain and remain compliant with the applicable business laws since there are less stringent operational regulations and reporting requirements. Nonetheless, the S corporation format is preferable if the business is seeking substantial outside financing or if it will eventually issue common stock. It is, of course, possible to change the structure of a business if the nature of the business changes to require it, but doing so often involves incurring a tax penalty of one kind or another. Therefore, it is best if the business owner can determine the most appropriate business entity choice when first establishing the business.

In addition to the basic legal requirements for various types of business entities that are generally codified at the federal level, there are variations between state laws regarding incorporation. Therefore, it is generally considered a good idea to consult with a corporate lawyer or accountant to make an informed decision regarding what type of business entity is best suited for your specific business.