When you’re starting or growing a business, choosing the right legal structure isn’t just a technical decision — it can significantly impact your taxes, legal liability, and overall operations. Two of the most common options for small businesses in the U.S. are the LLC (Limited Liability Company) and the S Corporation (S Corp). But which one is right for you?
In this blog, we’ll walk you through the five most important differences between LLCs and S Corps, helping you understand their pros, cons, and how they can even work together to benefit your business.
1. LLC vs. S Corp: Legal Structure vs. Tax Status
Let’s clear up a common misconception: an LLC and an S Corporation are not mutually exclusive. An LLC is a legal business structure, while an S Corp is a tax classification under the IRS.
You can form an LLC and then elect to have it taxed as an S Corporation. This means you can enjoy the legal protections of an LLC while taking advantage of potential tax savings that come with S Corp status.
In short: LLC is the foundation; S Corp is an add-on for tax purposes.
2. Taxation: How Much You Pay Matters
One of the most significant differences between the two comes down to how your business is taxed.
- A single-member LLC is taxed like a sole proprietorship by default. You pay self-employment tax (15.3%) on all your business profits, in addition to regular income tax.
- If your LLC elects to be taxed as an S Corp, you can split your income into a salary (which is taxed for Social Security and Medicare) and distributions (which are not subject to self-employment tax).
For example, if your business profits are $100,000, you could pay yourself a $50,000 salary and take the other $50,000 as distributions — potentially saving thousands in self-employment taxes.
3. Administrative Complexity
LLCs are generally simpler to manage. After forming your LLC with your state, you don’t need to follow strict corporate formalities — though it’s recommended to create an operating agreement and keep records of major decisions.
S Corps, on the other hand, require more ongoing administration, including:
- Creating bylaws
- Issuing stock
- Holding annual shareholder and director meetings
- Keeping detailed meeting minutes
These additional steps can add time and cost, which is why many business owners choose to consult with accountants or legal professionals before making the switch to an S Corp.
4. When S Corp Status Makes Sense
The biggest benefit of electing S Corp taxation is the potential for significant tax savings — but it’s not ideal for everyone.
As a general rule, if your business earns over $80,000 in annual profit, electing S Corp status may be worth considering. But the key is your “reasonable salary” — the IRS requires that the amount you pay yourself reflects what someone in your position would typically earn. You can’t just label most of your income as tax-free distributions.
Also, not every state recognizes S Corp status for state tax purposes, so your federal and state tax filings may differ, adding some complexity.
5. Ownership Rules and Flexibility
Ownership and structure flexibility are also areas where these two models differ:
- LLCs can have an unlimited number of members, including foreign individuals and entities.
- S Corps are limited to 100 shareholders, and all must be U.S. citizens or permanent residents.
- S Corps cannot be owned by other companies, LLCs, or most trusts, while LLCs have no such restrictions.
- LLCs can divide profits and losses however they choose (not strictly by ownership percentage), while S Corps must distribute profits based on shareholder ownership percentages.
If you plan to bring on investors or partners — or want maximum flexibility in allocating profits — this could make the LLC a better choice.
Conclusion: Which Should You Choose?
There’s no one-size-fits-all answer to the LLC vs. S Corp question. If you’re just getting started or want to keep things simple, an LLC might be the better option for now. But if your business is earning solid profits, choosing to have your LLC taxed as an S Corp can help you save big on taxes each year.
Need help deciding what’s best for your business?
At Martinez Income Tax, we specialize in guiding small business owners through the process of forming an LLC, electing S Corp status, and optimizing their tax strategy.
Contact us today to schedule a consultation and start building a business structure that saves you money and protects what you’ve worked hard to build.
