LLC vs. S Corporations - The Basics

New business owners often inquire about the differences between an S-Corp and an LLC. I get the proverbial “My accountant suggests an S-Corp, but I have read about an LLC.” This is a very common dilemma which usually has an easy answer.

First, let’s cover the basics:

S corporation
Generally, an S corporation is a regular corporation with regular limited liability under state law, but elects (per IRS Form 2553) pass through status for federal tax purposes. Now, what does that mean?

First, an S corporation provides the same liability protection to its shareholders as a C corporation (i.e. shareholders’ exposure is limited to the amount they have invested in the corporation).

Second, the S corporation pays no federal taxes (however, there are certain cases where the corporation where it will have to pay taxes if it was a C corp at one time). The income or loss passes through to the shareholders of the corporation. The income or loss is included on the individual income tax returns of the shareholders. Unlike the C corporation, the S corporation only pays one level of income tax on the S corporations’ income.

In addition, distributions to a shareholder of an S corporation are tax-free to the extent of the shareholder’s basis in the stock of the S corporation.

There are several advantages that an S corporation has over a C corporation. S corporations offer their shareholder/employees a possible way to avoid some self-employment taxes, the S corporation are often easier to administer, and the aforementioned single level of tax.

However, an S corporation does have its disadvantages. Some of the more important disadvantages are its limitations of shareholders, its limits on classes of stock, and its restrictions on types of stockholders.

When would you want an S corporation set up? Real estate development with appreciated property.

Limited Liability Company - LLC
The limited liability is a new entity which is essentially a hybrid of a corporation and a partnership.

First, like an S corporation, an LLC provides liability protection to its members (there are no shareholders of an LLC).

Second, an LLC is less rigid than a corporation is. Unlike a corporation where profits are distributed based on shareholder ownership, profits can be distributed per the Operating Agreement. The LLC is much easier to administer. For example, there is generally no need to have corporate minutes. In my humble opinion, this makes it easier to avoid liability because there is less likelihood that an LLC will fail to follow corporate formalities since there are less formalities to begin with.

There are some disadvantages to an LLC. It is harder to transfer ownership of an LLC, the law is still developing in this area because of uncertainties, and the cost to organize an LLC is more expensive (this is not the case in Maryland).

Personally, I prefer the LLC to an S corp. Why? Simplicity and the ability to elect its tax treatment. The tax treatment depends on the membership of the LLC.

A single member LLC can elect to be disregarded as an entity or as a corporation, even an S corporation. If a single member LLC elects to be disregarded as an entity, the income and loss of the LLC will be passed directly through to the individual owner as income or loss in the year earned on Schedule C of the tax return.

A multi member LLC can elect to be taxed as a corporation or a partnership.

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This blog will be used to post education articles regarding all aspects of corporate and estate planning law.