Choosing the Right Business Structure

Every new business starts with a spark, an idea. With time and intention, it eventually grows into a brand, and, at some point, a question arises that many business owners and leaders must face: How should I structure my business: LLC or S Corp?

It’s an important decision because the S Corp vs. LLC decision shapes how your business operates. Both LLCs (Limited Liability Companies) and S Corporations are legal entities designed for small to mid-sized businesses. They both offer liability protection to support business owners.

But they’re also quite different. Ownership, taxation, and compliance requirements can make the decision between an S Corp vs. LLC difficult and, frankly, confusing.

If you’re a company founder, small business owner, or freelancer, you need to choose a business structure that makes sense for you—and that starts with a bit of clarity.

This post will give you that clarity, so you can choose the right entity based on tax treatment, long-term goals, and operational flexibility.

What is an LLC?

An LLC is known for its flexibility. You create a legal entity to separate members’ personal assets from business liabilities, but without the formalities of a corporation.

LLCs are treated as pass-through entities for tax purposes, meaning the business itself doesn’t pay federal income tax and bypasses corporate-level taxes. Instead, business profits “pass through” to the members of the LLC and are reported on their personal tax returns.

The flexibility of LLCs attracts entrepreneurs because they aren’t bound by as many rules while building a business that can be unpredictable.

What is an S Corp?

An S Corp isn’t a business entity, but a tax option that’s available to LLCs or corporations that meet certain IRS requirements. You still get the pass-through taxation of an LLC while avoiding double taxation. An S Corp allows owners to divide income between salaries and distributions.

That division between salary and distributions is key because it can reduce self-employment taxes, a benefit that leads many business owners down the S Corp path. However, stricter rules and a more structured approach can present challenges. There are limits to the type of shareholders and reasonable salaries must be paid to the owners.

S Corps can be more attractive after a business is profitable and when tax optimization becomes more important than flexibility.

Key differences between S Corp and LLC

When it comes to an S Corp vs. LLC, the differences boil down to two main things: structure and complexity. LLCs provide more adaptability. S Corps provide more efficiency, specifically tax efficiency.

Tax treatment

Ownership and formation rules

Generally, LLCs are more welcoming and adaptable, and S Corps are more selective, which is reflected in their different rules.

LLCs offer flexible ownership and management rules. They can have an unlimited number of members, including foreign individuals and entities, or can be formed with a single member. Ownership percentages and profit-sharing arrangements are fully customizable, allowing members to structure the company in a way that best fits their business and financial goals.

An S Corp is subject to more restrictive ownership and governance rules. It may have up to 100 shareholders, all of whom must be U.S. citizens or residents. Only one class of stock is permitted, which requires ownership and profit distribution to be strictly proportional among shareholders. In addition, if the entity is elected to be treated as a corporation, it must maintain a formal corporate structure, including a board of directors.

Compliance and formalities

The day-to-day differences between an S Corp vs. LLC really start to emerge when it comes to compliance, formalities, and reporting requirements.

LLCs require:

• Basic bookkeeping
• Fewer filings
• Minimal formalities

S Corps are more rigid and must include:

• Payroll processing
• Employment tax filings
• Corporate meeting minutes
• Separate tax returns
• Reasonable salary documentation

While S Corps require more administrative work, they can offer tax advantages if you’re able to do the work to maintain them.

Profit distribution

Generally, LLCs give you more flexibility with profit distribution. Profits can be distributed however members decide. S Corp profits are distributed in proportion to ownership shares.

When should you choose an LLC?

An LLC may be a better choice for:

• Flexibility. Solo entrepreneurs, freelancers, or people just starting their business have more say over who owns and manages the LLC. You can also choose to be taxed as a pass-through entity or a corporation.
• Simplicity. Fewer reporting requirements and formalities can simplify set-up and management and may cost less.
• Ownership options. There aren’t any restrictions on owner citizenship, so foreign investment is an option.
• Profit distribution. You can reinvest profits rather than taking large distributions.

When should you choose an S Corp?

S Corp may be a better choice for:

• Reducing self-employment taxes. Owners have the option of paying themselves a salary with access to distributions and other profits that aren’t subject to self-employment tax.
• U.S.-based businesses. S Corps require that shareholders be U.S. citizens or legal residents, so U.S.-based businesses can take advantage of the benefits an S Corp provides.
• A small number of shareholders. You can have up to 100 U.S. shareholders in an S Corp.
• Longer-term planning. LLCs may need to be dissolved if an owner dies or after a certain timeframe, so an S Corp is preferable if you want your business to go the distance.

Can an LLC become an S Corp?

Yes, an LLC can become an S Corp—not by changing what it is, but by changing how it’s taxed.

The legal entity and the name stay the same. What changes is a form filed with the IRS (Form 2553). This clarifies that the legal structure will be an LLC, but the business will be taxed as an S Corp.

This hybrid setup allows you to grow into complexity, rather than start there. You get the flexibility of an LLC, with the pass-through taxation of an S Corp. Of course, you still need to comply with state laws governing LLCs.

To be taxed as an S Corp, there are certain requirements you need to meet:

• Have fewer than 100 shareholders who are U.S. citizens or legal residents
• Have one class of stock
• Maintain restrictions on the types of stocks and shareholders being issued
• Pay reasonable salaries to employees

You may also have to follow other S Corp rules, like keeping reliable business records and filing annual state and federal reports with the necessary federal agencies.

There are complexities with this hybrid structure, but working with a qualified tax attorney and accountant will ensure you’re complying with IRS regulations and other state or federal laws.

Practical decision factors: LLC vs. S Corp

When you’re asking yourself, “Should I choose an LLC or an S Corp?”, what you really need to consider is the type of business you have right now.

Consider the following:

• Number and type of owners. If you currently have several owners or investors, or plan to expand internationally, an LLC is probably the better option. In contrast, if you have limited owners who are U.S.-based, an S Corp may work better.
• Salary options. If you take a salary, then an S Corp is your best bet because owners who take a salary can avoid some of the self-employment taxes.
• Administrative resources. If you want less paperwork or don’t have the administrative resources, choose an LLC. Even if you can file payroll and do reporting, you need to decide if you want to, because an S Corp will certainly require more paperwork.
• Future investment or growth plans. If long-term growth and expansion are your goals, consider an S Corp. Depending on your state, LLCs can come with limitations, and you may need to dissolve the LLC under certain circumstances.
• Compliance requirements. When it comes to choosing an S Corp vs. LLC, you’ll encounter requirements and regulations for both (getting an EIN, reporting, meetings, recordkeeping). However, S Corps have stricter requirements. You’ll need to think about whether you have the time, energy, and resources to devote to an S Corp structure.

FAQs: S Corp vs. LLC

Can a non-U.S. citizen own an S Corp?

No. An S Corp must be 100% U.S. citizen or resident-owned. Non-U.S. citizens typically choose an LLC since they allow foreign ownership.

Can an LLC choose to be taxed as an S Corp?

Yes, an LLC can be taxed as an S Corp if it meets certain IRS criteria and files IRS Form 2553.

Which is better for taxes—LLC or S Corp?

It depends on your business structure and profitability. S Corps may save on self-employment tax and benefit higher earners or businesses that are profitable, but they are more complex to manage. LLCs offer simplicity for smaller businesses with less predictable profits.

Which is easier to run?

LLCs generally have fewer requirements and formalities, which make them easier to manage day-to-day.

Do both offer liability protection?

Yes, both structures limit personal liability for business debts and lawsuits, thereby protecting assets like homes and savings.

Choose the structure that aligns with your goals

When choosing how to structure a business, there isn’t one right answer for which is best. What’s most important is choosing the structure that matches where your business is today and your administrative tolerance.

Both offer liability protection and pass-through taxation, but you must choose between the flexibility of an LLC and the tax benefits and stability of an S Corp. You can always start as an LLC and transition into an S Corp later, or structure as an LLC and opt to be taxed as an S Corp.

The good news is you have options. Whether you’re building a global team or keeping it local, you just need to set your goals and get the right support behind you. Contact Pebl, we can help every step of the way.

This information does not, and is not intended to, constitute legal or tax advice and is for general informational purposes only. The intent of this document is solely to provide general and preliminary information for private use. Do not rely on it as an alternative to legal, financial, taxation, or accountancy advice from an appropriately qualified professional. The content in this guide is provided “as is,” and no representations are made that the content is error-free.

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