When clients are considering what business entity is appropriate for their new business, they frequently ask what the differences are between a Limited Liability Company (“LLC”) and an S corporation. This article highlights some of the more significant differences between these two types of business entities.
S corporations are more restrictive of ownership. S corporations can have no more than 100 shareholders. S corporation shareholders must be individuals, estates, certain trusts, or certain exempt organizations. Individual S corporation shareholders must be U.S. citizens or residents. S corporations can only have one class of stock. In contrast, LLCs can have unlimited owners, setup different classes of ownership, and be owned by any person or entity. S corporations have less flexibility with the allocation of income, gain, loss, deduction, and credits. S corporations are required to distribute income, gain, loss, deduction, and credits to the shareholders in proportion to their stockholdings, whereas the owners of LLCs can determine the allocation of income, gain, loss, deduction, and credits. Debt of the business entity affects an owner’s tax basis in the business differently based on choice of business entity. An LLC member’s basis includes the member’s share of the LLC’s debt. An S corporation shareholder’s tax basis in the business generally does not include debt incurred by the S corporation. The choice of business entity also affects self-employment taxes. S corporation shareholders do not pay self-employment taxes on their share of business profits, whereas LLC members that are active in the business are required to pay self-employment taxes on their share of business profits.