There are three main differences between an S-Corporation “S-Corp.” and a Limited Liability Company “LLC”. These differences are (1) ownership restrictions, (2) the treatment of self-employment tax and (3) the distribution of profits and losses.
The ownership restrictions for an S-Corp. are much more substantial than those of an LLC. Pursuant to IRS code section 1362, an S-Corp. cannot have more than 100 shareholders. While this provision is very limiting, it does allow for a family to count as one shareholder. S-Corps. also have a limitation on who can be a shareholder. A shareholder must be either US citizens or resident aliens. What this means is that no corporations or LLCs may be a shareholder of an S-Corp. Finally, an S-Corp. may only have one class of stock. However, the S-Corp. can differentiate whether the shareholders are able to have voting rights in that one class of stock.
In contrast, ownership restrictions for an LLC are nearly nonexistent. In a limited liability company the owners are called members rather than shareholders. An LLC is unlimited in the number of members allowed to participate. Like an S-Corp., members of an LLC can be US citizens and resident aliens, however additional entities such as a corporation, LLC and any individual person regardless US resident status are also permitted to be members.
The next difference between an S-Corp. and an LLC relates to the treatment of self-employment tax. With regard to the LLC the treatment is straight forward. The member of an LLC must pay self-employment tax on all net income generated by the LLC. This amount is currently 13.3%.
The self-employment tax treatment of an S-Corp. is more complex than that of an LLC. If the shareholder of an S-Corp. works for the corporation the shareholder will be paid a reasonable salary set by the corporation for the work performed by the shareholder. The shareholder will pay self-employment tax on their portion of income that is derived from the reasonable salary. The remaining income distributed to the shareholder and will be taxed as ordinary income.
The final difference addressed in this post relates to the permissible behavior with regard to the distributions of profits and losses. With an S-Corp. there are no special allocations of profit and losses for shareholders. Corporate profits and losses must be split up proportionately to the percentage of shares owned by each shareholder. On the other hand an LLC has the ability to decide what percentage of the LLC’s profits and losses each owner will be given regardless of a members ownership share in the LLC.