As a small business owner, choosing the right business structure can make a significant impact on your finances and legal obligations. Two popular business structures for small businesses are the limited liability company (LLC) and the S corporation (S corp). While they share some similarities, they differ in some significant ways.
Here are some key differences between an LLC and an S corp:
- Taxation
One of the significant differences between an LLC and an S corp is the way they are taxed. An LLC is a pass-through entity, which means that the profits and losses of the business are passed through to the owners’ personal tax returns. As a result, LLC owners are required to pay self-employment taxes, which include Social Security and Medicare taxes, on their entire share of the profits.
On the other hand, an S corp is also a pass-through entity, but it is subject to different tax rules. Instead of paying self-employment taxes on their entire share of the profits, S corp owners pay themselves a reasonable salary and only pay self-employment taxes on that amount. The remaining profits are distributed to the owners as dividends, which are not subject to self-employment tax.
- K-1 Forms
Another significant difference between an LLC and an S corp is the way they issue tax documents to their owners. LLCs issue a Schedule K-1 form to each member, which outlines their share of the profits and losses for the year. This form is used to report the LLC’s income on the owner’s personal tax return.
S corps also issue K-1 forms to their owners, but they are only issued to shareholders who own more than 2% of the company’s stock. The K-1 form reports the shareholder’s share of the company’s profits and losses and is used to report the S corp’s income on the owner’s personal tax return.
- Ownership and Management
LLCs and S corps also differ in terms of ownership and management. An LLC can have an unlimited number of owners, known as members, who can manage the business themselves or hire a manager to run the company. In contrast, S corps are limited to 100 shareholders, and all shareholders must be U.S. citizens or residents.
Additionally, S corps must have a board of directors that oversees the company’s operations and makes major decisions. The board of directors hires officers, such as a president, vice president, and secretary, to manage the company’s day-to-day operations.
- Draws and Distributions
Another difference between an LLC and an S corp is how owners can access the profits of the business. LLC owners can take a draw from the company’s profits whenever they choose, which is essentially a withdrawal of funds from the business. The amount of the draw is not subject to self-employment tax.
S corp owners, on the other hand, can take distributions of the company’s profits, which are also not subject to self-employment tax. However, unlike an LLC draw, an S corp distribution must be proportional to the owner’s ownership percentage in the company.
In conclusion, choosing between an LLC and an S corp depends on your business’s unique needs and goals. While an LLC may be more straightforward to set up and manage, an S corp offers potential tax benefits for its owners. Consult with a qualified accountant or attorney to determine which structure is best for your business.
