LLCs v. S Corporations: Which One Is Better For Your Business

Most people are familiar with limited liability companies (LLCs) but few are aware of S corporations. Depending on the nature and structure of your business, an S Corporation could be a better choice of business entity than an LLC. Generally, S corporations are corporations that elect to pass the corporation’s income or losses to its shareholders and do not pay any federal income taxes. In order to receive this tax benefit, the corporation must make a valid election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. The S status combines the legal benefits of C corporations with the tax benefits of partnerships. The advantages and disadvantages of S corporations and LLCs will be discussed below for your benefit.

Advantages of S Corporations over Limited Liability Companies

1.    Employee Status. S shareholders are regarded as employees of S corporations while members (i.e. partners) are not regarded as employees of an LLC. This means that certain income of LLC members is subject to the self-employment tax. Owners in an S corporation do not pay this tax or the payroll tax. This is a huge benefit that S corporations have over LLCs.

2.    Fringe Benefits. Certain fringe benefits, such as health insurance, can not be excluded from an LLC member’s income but are excluded from the income of an S shareholder who owns 2% or less in an S corporation

3.    Income Shifting to Family Members. S corporation profits can be shifted to family members by making gifts of stock to the members. The family partnership rules make it more difficult to shift income to family members through an LLC.

Advantages of Limited Liability Companies over S Corporations

1.    Profit and Loss Sharing. LLC profits and losses are allocated to the LLC members based on a profit sharing agreement. This gives an LLC more flexibility as to how much of the income and losses each LLC member reports. S Corporations do not have this benefit, as their profits and losses are allocated pro rata based on stock ownership.

2.    Eligibility of Owners. With LLCs, there is no ownership restriction. However with S corporations, there can be no more than 100 shareholders and ownership is restricted to individuals, estates and certain trusts. Nonresident aliens are not permitted to be owners of S corporations.

3.    Deductibility of Losses. The deductibility of entity losses is limited by the at-risk basis of an LLC member or S shareholder in the entity. The at-risk basis of an LLC is usually larger than of an S corporation because debt can be used in LLCs to raise the limit on the deductibility of losses. This means that LLC members can potentially deduct higher losses from their taxable income than S shareholders.