Both options are ideal for small businesses. In fact, an S-Corp can only have a maximum of 100 shareholders with a single stock class. They must also be US citizens. Revenue generated by the S-Corp will “pass through” to shareholders – owners – but will not be taxed for Social Security or Medicare. This is considered one of the main tax benefits of an S-Corp. However, it is important to keep in mind that an S-Corp has a fairly rigid set of policies and rules. For example, revenue distributed to owners is determined strictly by shares owned (whereas this is not the case in an LLC).
A Limited Liability Corporation has the same pass through policy as an S-Corp, but in this case members must pay Social Security and Medicare taxes (known as self-employment tax). Shareholders are personally protected from debt liabilities of the business. It is possible for another corporation to join an LLC, not just an individual. Additionally, an LLC can be formed very quickly with fewer “hoops to jump through” than an S-Corp.
LLC’s are considered to be more flexible than S-Corps. They allow members to state their taxation status. This is why LLC’s are a great option for both individuals and partnerships (between individuals or, for example, two corporations).
The main thing to remember is that with an S-Corp one can be assigned a salary and a distribution (similar to dividends) and will be taxed differently – only paying traditional income tax on the salary. An LLC however requires income tax to be paid on all profits, as well as self-employment tax as was mentioned above.
Small businesses generally choose to form an LLC for ease of operation. They can be formed faster and have far fewer regulations. Time spent on paperwork, legalities and other possibly unforeseen difficulties are avoided. However, for those with the right business and capabilities, an S-Corp may offer a considerable reduction in taxes.
Of course, all businesses and situations are different. The best advice you can follow when deciding between an LLC and an S-Corp is to seek the counsel of a certified public accountant (CPA). Persons with this qualification are trained to recognize and troubleshoot the various pitfalls and complications that can arise when dealing with issues related to taxes and the IRS.