LLC vs. S Corporation: Understanding the Differences and the Benefits of Electing S-Corp Status
Choosing the right business structure is one of the most important decisions a business owner can make. Two of the most common options for small businesses are the Limited Liability Company (LLC) and the S Corporation (S Corp). While many people think they are completely different entities, the truth is a little more nuanced.
Understanding how they differ — especially in taxation — can help you determine which structure best supports your business growth and financial goals.
What Is an LLC?
A Limited Liability Company (LLC) is a legal business structure formed at the state level. It provides liability protection, meaning the owner’s personal assets are generally protected from business debts and lawsuits.
By default:
A single-member LLC is taxed as a sole proprietorship.
A multi-member LLC is taxed as a partnership.
In both cases, profits “pass through” to the owner’s personal tax return. The business itself does not pay federal income tax.
Advantages of an LLC:
Simple to form and maintain
Flexible management structure
Fewer formal requirements
Pass-through taxation
Personal liability protection
However, one major consideration is that all business profits are typically subject to self-employment taxes (Social Security and Medicare).
What Is an S Corporation?
An S Corporation is not a type of legal entity — it is a tax election made with the IRS. An LLC or corporation can elect to be taxed as an S Corp by filing Form 2553.
Like an LLC, an S Corp provides pass-through taxation. However, the key difference lies in how owners are taxed on business income.
Key Differences Between an LLC and an S Corp
1. Tax Treatment
This is the most significant difference.
LLC (Default Taxation):
All net profits are subject to self-employment tax (15.3% for Social Security and Medicare, up to certain limits).
S Corporation:
Owners must pay themselves a “reasonable salary” through payroll. That salary is subject to payroll taxes. However, additional profits can be taken as distributions — which are not subject to self-employment tax.
This can create substantial tax savings once a business becomes consistently profitable.
2. Payroll Requirements
An LLC does not require the owner to run payroll for themselves.
An S Corp requires owners who actively work in the business to pay themselves a reasonable salary through payroll.
This adds administrative responsibility but creates tax planning opportunities.
3. Ownership Rules
S Corporations have stricter ownership requirements:
Maximum of 100 shareholders
Shareholders must be U.S. citizens or residents
Only one class of stock allowed
LLCs are generally more flexible with ownership structure.
4. Formalities and Compliance
S Corps typically require:
Payroll filings
Corporate record keeping
More structured compliance
LLCs have fewer ongoing formal requirements.
The Benefits of Electing S-Corp Status
For many small business owners, the biggest advantage of an S Corp election is tax savings.
1. Reduced Self-Employment Taxes
This is the primary benefit.
Example:
If your business earns $100,000 in net profit:
Under default LLC taxation, the full $100,000 may be subject to self-employment tax.
Under S Corp taxation, you might pay yourself a $60,000 salary (subject to payroll taxes) and take $40,000 as distributions (not subject to self-employment tax).
That difference can result in thousands of dollars in annual tax savings.
2. Credibility and Professional Structure
Running payroll and maintaining corporate records can add structure and professionalism to your business operations.
3. Clear Separation Between Owner and Business
Paying yourself a salary encourages better financial discipline and helps maintain a strong separation between personal and business finances.
4. Tax Planning Opportunities
An S Corp structure allows for more strategic planning in areas such as:
Retirement contributions
Health insurance deductions
Profit distribution timing
When Does an S Corp Make Sense?
An S Corp election is typically beneficial when:
Your business is consistently profitable
You are earning more than what would be considered a reasonable salary for your role
You can comfortably cover payroll and administrative costs
If your business is still in startup mode or earning minimal profit, remaining a default LLC may be simpler and more cost-effective.
Final Thoughts
An LLC and an S Corporation both offer liability protection and pass-through taxation. The key difference is how business profits are taxed.
For growing businesses, electing S Corp status can significantly reduce self-employment taxes and create long-term savings. However, it also comes with additional compliance responsibilities.
Choosing the right structure should be based on your income level, growth goals, and long-term financial strategy.
Before making a change, it is always wise to consult with a tax professional who can evaluate your specific numbers and determine whether an S Corp election will truly benefit your business.