Should you form an LLC or an S corporation?

Differentiating between LLCs and S corps

While they both determine the classification of your business, they’re not in the same category: An LLC is a business structure, while an S corp is a tax classification. You can open an LLC and be taxed as an S corp to gain a tax advantage at both the federal and state levels.

Grow a business

Use free apps and tools from microsoft for your small business and side gig.

Learn more

If the difference between an LLC and an S corporation seems confusing, you’re not alone. But understanding the differences can potentially save you thousands in taxes. And choosing the way you organize your business can significantly impact your success.

What is an LLC?

A limited liability company (LLC) is a business structure that protects your personal assets from your business liabilities. By combining the liability protection of a corporation with the flexibility and simplicity of a partnership, LLCs are popular for new businesses of all sizes. LLCs are relatively easy and inexpensive to set up and maintain and they don’t affect your own taxes: even if you’re a freelancer or solo proprietor, setting up an LLC is a good idea to bypass your personal finances.

What is an S corporation?

An S corporation (S corp) is also a type of business entity that offers the same liability protection as a C corporation (C corp), but avoids paying corporate income tax such as a traditional C corp. This S corp structure comes with regulations aimed at small businesses: for example, your business can’t have more than 100 shareholders, and you can only have one class of stock. S corps are often chosen by businesses that plan to reinvest their profits into the company rather than distributing them to shareholders.

So which one is right for your business?

An LLC pays more in taxes than a business with S corp status as LLCs are taxed at the self-employment tax rate of 15.3%. Opting for S corp taxation means that you as the business owner are considered an employee and you can pay yourself through payroll and be taxed at a lower rate.

The choice between an LLC and an S corporation depends on several factors, including your business’s size, industry, and long-term goals. Here are some pros and cons to help you make an informed decision:

LLC Pros:

• Simple and flexible structure
• No limit on the number of owners
• Minimal compliance requirements

LLC Cons:

• Self-employment taxes on all income
• Limited ability to raise capital

S Corporation Pros:

• Limited liability protection
• Ability to raise capital through the sale of stock
• Prestige associated with being a corporation

S Corporation Cons:

• Strict eligibility requirements
• More complex compliance requirements
• No flexibility in allocating profits and losses among shareholders

Ultimately, the decision between an LLC and an S corporation should be based on your business’s specific needs and goals. If you plan to keep your business small and don’t need to raise capital, an LLC may be the best choice. On the other hand, if you plan to grow your business and need to raise funds, an S corporation may be the better option.

Budgeting for a business is a smart way of planning ahead for the future, but even if you don’t own a business, you can still manage your money like an expert. Learn how to set up an emergency savings fund, learn about amortization, or teach financial skills to your children—and raise a future generation of business owners.