LLC vs. S Corp: What tax implications are there for my business?
4 min read
September 20, 2023 • Block Advisors
As a business owner, when you start a new business you have to decide on the legal business entity for your new venture. While there are many business formation options to consider, many owners debate LLC vs. S Corp (that is Limited Liability Company vs. S Corporation).
When you examine the trade-offs between an LLC vs. S Corp, is there a true winner? And how does each structure impact your business from a taxation perspective? Or from a legal liability perspective? Read on to find out!
What’s the difference between an LLC and S Corp?
First, we should note that comparing LLCs to S Corps is not a real apples-to-apples situation as far as names go. An LLC is a type of business entity structure, whereas an S Corp is specifically related to tax structure.
To examine the difference between an LLC and S Corp, we’ll first define each:
What is an LLC?
A limited liability company, or LLC, is an entity set up under state statutes and, as its name indicates, provides liability protection for its owners, who are referred to as “members.” An LLC is not a recognized business structure by the Internal Revenue Service for federal tax purposes—it’s only a state designation.
Owners of an LLC are called members. Because most states don’t restrict ownership, members may include individuals, corporations, other LLCs, and foreign entities. There is no maximum number of members. Most states also permit single member LLCs, those having only one owner. Learn how single-member LLCs differ from sole proprietorships in our post on LLC vs sole proprietorships.
An LLC may choose how to be taxed for federal purposes.
Is an S Corp the best structure for my business?
Answer these six questions to help you find your fit.
For single member LLCs, the options are:
- Disregarded entity – (default) The LLC does not file a tax return. Instead, the activity of the LLC is included on the member’s individual return (more on this below).
- C Corporation
- S Corporation
For multiple member LLCs, the options are:
- Partnership (default)
- C Corporation (View the differences between an LLC vs. C corporations)
- S Corporation
What is an S Corp?
A corporation is an entity set up under state statutes meaning you form a corporation under state law. Then, you can go to the IRS to elect taxation as an S Corporation instead of a C Corporation.
An S Corporation, or S Corp, is an IRS-recognized corporation that elects to pass through its income and losses through to its shareholders. It’s sometimes referred to as a Subchapter S corporation.
To elect to become an S Corp, you must file Form 2553.
To qualify for S Corporation status, your business must:
- Be a domestic corporation
- Have allowable shareholders
- Have no more than 100 shareholders
- Hold only one class of stock
- Not be an insurance brokerage, financial institution, or domestic sales corporation operating globally
Do these nuances seem overwhelming already? We can help. Block Advisors is here to help you make sense of the significant tax considerations and small business tax forms needed for this important business decision. Go deeper on Entity 101 to further understand the advantages & disadvantages of your business structure options. And, as part of your tax prep with one of our small business certified tax pros, you can get insight into the potential business entity tax classifications and how they could impact your taxes.
S Corp vs. LLC tax implications
S Corps and LLCs that choose this status are both pass-through entities. This means that taxes are passed through to the owners’ individual tax return. With both structures, you avoid double taxation of profits.
What are the key differentiators in evaluating LLC vs S Corp tax implications? Let’s review this from a few angles:
- LLC members may be required to pay self-employment taxes. Federal taxes are paid by individual owners, not the entity.
- Owners may be able to claim a self-employed health insurance deduction.
- Owners may be able to offset other sources of income with business losses.
Need help to better understand the tax difference between an LLC and S Corp
As a small business owner, deciding on the best business structure for your small business should not be a choice you make lightly. It affects your tax obligations, ability to raise funds, share distributions, and more. What we outline in this article are only some of the many factors to consider, and this is not intended to be legal advice or specific to any situation. We recommend you seek the advice of an attorney about the implications of entity selection.
Want to learn more about business registration? We’ve got your back. Visit the Block Advisors Business Formation page to get more resources to help you navigate this important step for your company.