Unlike standard C corporations, both S Corporations (“S Corps”)—corporations taxed under Subchapter S of the Internal Revenue Code—and limited liability companies (“LLCs”) are treated as pass-through entities for taxation purposes, which may lead to significant tax savings over the course of a business’s life.
Understanding the differences between an S Corp and an LLC is critical to ensuring you select the best structure for your company.
Tax Treatment and Structure
The most obvious difference between an S Corp and an LLC is the way the entity is treated for tax purposes. LLCs are treated as pass-through entities, which means that the income of the LLC flows through to its members’ individual tax returns, so the income is only taxed once. On the other hand, S Corps are accounting entities, meaning the S Corp itself calculates income and deductions at the corporate level before income is allocated to individual shareholders. That income then similarly passes-through to the individual shareholders’ tax returns.
S Corporation Potential Tax Advantage
S Corps may offer tax benefits to businesses that earn excess profits. S Corps must pay their employees “reasonable” salaries (comparable to others in the same industry); however, all excess profits can be distributed to shareholders as dividends, which are typically taxed at a rate lower than ordinary income is taxed.
LLCs Are Popular in Texas
In the State of Texas, over 89% of new entities are formed as limited liability companies.
LLCs are the most popular entity type because they:
- are easy to create and use
- are flexible (many governance & taxation options)
- protect the LLC’s owners from personal liability
- insulate the LLC’s assets from the LLC’s owners’ creditors
- profits and losses can be passed through without facing corporate taxes
Summary Chart
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The differences between S Corps and LLCs can be complex, and this article only highlights some of the key distinctions between them. The proper organization of your company is a critical decision that will impact its future success.
Please contact McGarvey PLLC for further information on this topic.
