When starting a small business, one of the first major decisions you’ll face is choosing a legal structure. For most entrepreneurs, this often comes down to the common comparison of S Corp vs. LLC. Understanding these distinctions is important because the structure you choose can significantly impact your taxes, take-home income, and long-term business setup.

However, the differences between the two can be confusing because they work in different ways and don’t serve the same purpose. This makes them hard to compare directly. In this guide, we’ll break down how each structure works and why one may be a better fit than the other, so you can make a clear and confident decision for your business.

What is an LLC?

A Limited Liability Company, or an LLC, is one of the simplest and lowest-risk business structures, making it a popular choice for small business owners and freelancers. The main advantage of setting up an LLC is the separation between personal assets and business liabilities. This means that if your business is sued or takes on debt, your personal bank accounts and property are protected.

LLCs can work for a variety of business types. They can be formed as a single-member LLC, which is owned by one person, or a multi-member LLC, which is owned by two or more people. For this reason, LLCs are suitable for solo entrepreneurs or companies with multiple business partners. 

By default, LLCs are pass-through entities. This means the business does not pay federal income tax, but instead, the profits and losses “pass through” to the owner’s personal tax return.

LLC vs Other Business Structures

LLC is one of the many different types of business structures you can choose. Here’s a breakdown of how it compares to other options.

A sole proprietorship is the simplest structure that is common with freelancers or beginners. This is where the business and the owner are legally the same. While it’s easy to set up, it offers no liability protection, meaning personal assets are not separated from business debts or legal issues. Knowing when to incorporate your business is important to protect your personal assets as your business grows.

A C Corporation is a more formal structure that is legally separate from its owners and pays its own corporate taxes. However, this means you might face double taxation, where the company pays taxes on its profits and owners may pay taxes on dividends when those profits are distributed.

What is an S Corp?

An S Corporation (or S Corp, for short) is a tax classification, not a separate type of business structure like an LLC. In fact, companies with an LLC can actually elect to be an S Corp on their taxes if they meet certain requirements.

This structure is largely designed to reduce the amount of self-employment taxes the business will owe. It also uses pass-through taxation, meaning the business itself generally does not pay federal income taxes, similar to an LLC. In addition, when paired with an LLC or corporation, it maintains limited liability protection, which separates personal assets from business debts or legal claims.

S Corp vs LLC Taxes

In terms of taxes, the key difference between S Corp vs LLC comes down to how income is treated. With an LLC, all profits made by the company are subject to self-employment taxes. But with an S Corp, only the payroll taxes on the owner’s salary are owed. This can result in significant tax savings, especially for small business owners with high incomes.

For example, let’s say your business made $100,000 in profit this past year. If you only have an LLC, then 100% of that income is subject to self-employment tax. However, choosing an S Corp means you can reduce self-employment taxes by taking part of your income as distributions instead of salary. So you pay yourself $70,000 as a salary (which is taxed), and the remaining $30,000 is taken as a distribution, which is not subject to self-employment tax.

Having an LLC and an S Corp

Because an LLC is a legal business structure and an S Corp is a tax classification, companies with an LLC can actually choose to be taxed as an S Corp. This means you don’t necessarily have to choose between an S Corp vs. LLC, since in many cases, they can work together. To sum it up, you can form an LLC when:

• Your business starts earning money, and you want to make things official
• You want liability protection that keeps your personal assets separate from your business.

However, you can also elect to file as an S Corp if you want additional tax savings. Here are a few situations where it might make sense for your business:

• You have high profits to cover the extra costs of payroll and admin costs.
• You have a reasonable salary that can be paid while still leaving room for distributions.
• You don’t mind doing extra administrative work (detailed record keeping and filing Form 2553 and Form 1120-S to the IRS)

Of course, you don’t have to make all these decisions at once. You can form your business as an LLC and later elect an S Corp when you make enough income and profit. That way, you reach a financial point where the tax benefits are actually worth it.

Know the S Corp vs LLC Difference

As you now know, it’s not about choosing S Corp vs LLC. Instead, it’s about understanding how each one works so you can make a decision that best fits your business at its current stage. While taxes may seem daunting to new business owners (regardless of having an S Corp vs LLC), it’s a key part of running a successful company! To help, here are a few tips to help you with business tax planning for financial success.

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