LLC vs. S-Corp: What’s the Difference?

As a small business owner, you have many important decisions to make — and whether you’re hiring qualified personnel, deciding on a brand strategy, or finding the best outsourcing resources to manage the workload professionally, you want your decisions to work for both your short and long-term goals and aspirations. However, none of these important decisions can be secured without a concrete understanding of your business’s fundamental structure. 

As you complete the first registration processes for your organization, you’ll need to compare the LLC and S-Corporation (S-Corp) structures. While these two options for smaller organizations are similar in some respects, they also differ in several important ways. In this article, we’ll define both of these models, explore their organizational and financial implications, and empower new companies to know which one best matches their specific goals and expectations. 

Basic definitions 

Before delving into the differences between the two most crucial small business identifiers, it’s important to understand each option at a basic level:

  • Limited liability companies, or LLCs, are comparably easier to establish and can be formed at any size — but they are most popular among family businesses, sole proprietorships, and partnerships. They are extremely flexible in terms of structure and can incorporate as many owners (called “members”) as needed. No member is personally liable for company-related lawsuits or debts. 
  • S-corporations, while also offering liability benefits, adhere to stricter legal requirements for ownership and operation. While S-Corp status is more difficult to acquire, it establishes more credibility among important stakeholders like investors and creditors compared to LLCs. 

Congress signed the Small Business Job Protection Act of 1996 as LLCs and S-Corps were just coming to the forefront of the commercial landscape. This legislation created equal opportunities for small businesses to compete with larger corporations, and clearly defined which owners should take advantage of S-Corp policies over those of LLCs and vice-versa.

Key differentiators 

The company structure that you choose can significantly impact several aspects of your annual proceedings — including tax rates, exposure to liability, and general operations. Here are the most important differences between the LLC and S-Corp structures that small businesses should consider before making their decision. 

Owner’s role 

Firstly, the term “owner” means different things in LLCs and S-Corps. While both are defined as decision-making roles, an owner’s relationship with the company differs depending on the company’s overall designation.  

LLCs may have an unlimited number of members that qualify as owners; however, a limit of 100 shareholders can claim ownership status within an S-Corp. These shareholders are presented legally as employees of the company instead of proprietors, as is the case in an LLC. 

Additionally, S-Corps are restricted in granting subsidiaries or offering financial preference to certain shareholders, while LLCs are not similarly restricted. 

Tax reporting requirements 

Because of these different ownership classifications, tax reporting requirements also differ between LLCs and S-Corps. LLCs file a Schedule C (Form 1040) on the owner’s personal tax return or a Partnership Return if there are more than one owner (Form 1065), reporting profits and losses from the business as a whole, and the S-Corp files a separate tax return using Form 1120S on the company’s behalf. 

Tax impact

Finally, profits from both LLCs and S-Corps are subject to income tax. But all individual members of an LLC are also subject to other taxes, such as self-employment tax — which currently sits at 15.3 percent.. Because of these additional tax burdens, the ownership freedom that comes with LLCs is offset by the fact that they are comparatively more costly to manage than S-Corps.  

Financial service requirements 

Despite tax reporting and impact differences, bookkeeping requirements are relatively the same between LLCs and S-Corps. Both are state-filed separate legal entities, and both are required to file annual reports and pay yearly fees to maintain their registration. And at a base level, both LLCs and S-Corps must handle a wide range of bookkeeping responsibilities — including reconciling bank and credit card accounts, tracking loan information like principles and interests, creating and sending customer statements, creating balance sheets and other essential reports, and much more. 

Because of these similarities, your standard for bookkeeping services can remain consistent. CPAs are an excellent resource for both LLCs and S-Corps looking to outsource quality bookkeeping management because of their extensive data entry skills, familiarity with essential annual tax information, access to high-quality accounting software, and well-established quality control procedures. 

Quality financial management for any business structure 

As you continue to develop your business strategy, making use of outsourced financial services is one of the best ways to ensure your finances are professionally managed each quarter. Matt Brady, CPA, and the team at Chesapeake Growth Network offer unparalleled financial guidance for small businesses from Bowie to Annapolis in a wide variety of industries, including healthcare, construction, nonprofit organizations, professional services, and many others. 

To access premier bookkeeping, accounting, and tax preparation CPA services — along with quality financial advisors and attorneys — contact Chesapeake Growth Network for more information. In our next article, we’ll explore healthcare in retirement and the ins and outs of Medicare and Social Security.

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