Taxation: Limited Liability Companies and S-corporations are alike in that both are “pass-through” entities for federal income tax purposes. In other words, the income from both these entities are” passed through” to its shareholders or members (owners) and reported as income (or loss) on the owners’ personal income tax returns. This reporting method eliminates the problem of double taxation encountered by owners of C corporations but does add additional problems.

The owners of an LLC are considered self-employed and, therefore, are required to pay self-employment taxes on all the profits earned by the LLC regardless of whether the owners take the profit as salary or distributions. These self-employment taxes help fund Social Security as well as Medicare programs and resemble the same taxes paid by most wage earners. Self-employment is taxed at a rate of 15.3%. 12.4% of the tax pays for social security benefits and the remaining 2.9% goes toward Medicare.

In an S-corporation, only the employee-owner's salary is subject to self-employment tax. The remaining income, under IRS rules, is paid as a distribution and thus is not subject to self-employment tax. Therefore, there is the potential to realize substantial employment tax savings. For example, if two individuals own an LLC that realized a $100,000.00 profit, each would be entitled to $50,000.00. Accordingly, each owner would owe $7,650.00 in employment taxes ($50,000.00 x .153)

However, if it were an S-corporation, each owner could take, for example, $30,000.00 as salary and $20,000.00 as a distribution. They would only be required to pay employment tax in the amount of $4590.00 ($30,000.00 x .153). The $20,000.00 distribution would not be subject to employment tax. Therefore, they would save $3060.00 in employment taxes by utilizing an S-corporation instead of an LLC. However, as the owners of an S-corporation, they would have to pay their taxes quarterly or incur penalties and interest. Furthermore, the paperwork associated with an S-corporation can be onerous at times.

Number of Owners: An S-corporation must have 75 or fewer shareholders vs. an LLC, which is not restricted as to number of members or owners.

Ownership by Non-U.S. Residents: Unlike an S-corporation, non-residents can own LLCs.

Ownership by Other Entities: LLCs may be owned by C-corporations, S-corporations, many trusts, limited liability companies, or partnerships. S-corporations may not be owned by any of these entities.

Division of Profits: S-corporations do not have any flexibility in the way profits are distributed amongst the owners. Profits are required to be distributed according to the percentage of stock ownership, notwithstanding the fact that the owners themselves might believe that profits might be more equitably distributed. However, with an LLC, a member’s share of the profits is not tied to his or her ownership percentage. The member/owners of a Limited Liability Company (LLC) may distribute the profits amongst themselves as they feel is appropriate and are not required to distribute profits strictly according to one’s percentage of ownership.

Back to Corporate Formation