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Updated Jan 09, 2024

Should You Set up Your Business as an LLC or an S Corporation?

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Simone Johnson, Business Strategy Insider and Senior Writer

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When starting a business, you can choose from several business entity types. Limited liability companies (LLCs) and S corporations are popular options, but they differ in many ways, including taxes and management structure. Sometimes, a business may be both an LLC and an S corp. Here’s what you need to know about these business types and their differences before you decide which is right for your business.

What is an LLC?

A limited liability company (LLC) is a business structure that protects the personal assets of the business’s owners (referred to as “members”). Suppose the business gets tangled in legal troubles or is sued by a debt collector. In that case, the plaintiff or creditor can only go after the business’s assets, not the LLC members’ personal assets.

If the LLC is taxed as a sole proprietorship, it has the tax advantages of being a pass-through entity, which means its profits “pass through” the business to the LLC members. They can report the profits on their personal tax returns rather than filing a corporate tax return. The LLC members must pay self-employment tax on their income.

Alternatively, an LLC may be taxed as an S corp, which means the member must be paid a reasonable salary. The LLC reports the owner’s salary as a business expense and deducts payroll taxes. The business’s remaining profits are distributed as dividends.

Did You Know?Did you know

LLCs have specific tax considerations to keep in mind. Consider using one of the best online tax software packages to assist with your LLC taxes.

What is an S corp?

An S corporation, also called an S corp or an S subchapter, is a tax election that lets the IRS know your business should be taxed as a partnership. It also prevents your business from incurring corporate-level double taxation. To become an S corp, your business must first register as a C corporation or an LLC. 

In an S corp, the business owners are called shareholders. As an owner, you are considered an employee of the business and must pay yourself a reasonable salary. An S corp’s profits, losses, deductions and credits are taxed at the shareholder level.

To qualify as an S corp, your business can have one to 100 shareholders. Your business also must be located in the U.S., and you must file with the IRS as an American corporation.

What is the difference between an LLC and an S corp?

Small business owners often choose to structure as an LLC because it offers more freedom than corporation structures do. But before you make this critical decision, it’s important to know the differences between LLCs and S corps. 


In an LLC, members must pay self-employment taxes – Social Security and Medicare taxes – directly to the IRS. These tax rates change annually, but the self-employment income tax rate in 2022 is 12.4% for Social Security and 2.9% for Medicare, according to the IRS. Any income an LLC generates is considered taxable income.

With an S corp, shareholders are paid a salary, and the business pays their payroll taxes, which can be deducted as a business expense from the company’s taxable income. If the business has leftover profits, they are distributed to shareholders as dividends, which have a lower tax rate than regular income does.

Management structure 

LLCs and S corps also differ in management, according to Guy Baker, founder of Wealth Teams Alliance. 

“When members manage an LLC, the LLC is much like a partnership or a sole proprietorship if there’s only one member,” Baker said. “If run by managers, the LLC more closely resembles a corporation, as members will not be involved in the daily business decisions.” 

S corps generally have directors and officers; a board of directors oversees corporate formalities and major decisions, and the directors elect officers who manage daily business operations, Baker said. 

Shareholder structure, subsidiary restrictions and stock

S corps can’t have more than 100 shareholders, but an LLC can have unlimited members. Additionally, S corps can’t have non-U.S. citizens as shareholders, but an LLC allows non-U.S. citizens to be members.

S corps and LLCs also have different subsidiary restrictions: LLCs are allowed subsidiaries without restriction, while S corps aren’t allowed to set up any subsidiaries. 

Finally, LLCs cannot issue stock, while S corps can, though they can issue only one class of stock.

Did You Know?Did you know

Choosing a business legal structure requires extensive research on issues of taxation, management, liability, fundraising, corporate hierarchies and more.

Is an LLC or an S corp better for entrepreneurs?

Honestly, it depends. Filing to become an LLC is a good approach to begin with because this structure offers liability protection and tax write-offs. However, as your business grows beyond the startup stage, switching to an S corp may make financial sense. As income from the LLC increases, so does the self-employment tax, according to Vincenzo Villamena, CPA and managing partner at Global Expat Advisors. 

“With an LLC, the income passes through to the owner, who has to pay 15.3% self-employment tax,” Villamena said. “If the owner resides abroad, the Foreign Earned Income Exclusion can minimize income tax but not self-employment tax. With an S corporation, on the other hand, the owner can take a salary from the profits and apply the Foreign Earned Income Exclusion to minimize income tax.” 

S corps may make more sense financially for many businesses, but unless there is a specific reason to make the switch, it may not be the best move for a single-member LLC, according to Anthony Viola, CPA and senior partner at Marks Paneth LLP. 

“I personally like the flexibility that LLCs offer business owners,” Viola said. “Yes, there’s the downside of having to pay self-employment taxes, but in an S corp, the owners are required to take salaries under the IRS’s reasonable compensation regulations.” 

Are certain types of businesses better suited for LLCs or S corps?

Across all industries, sole proprietorships and partnerships may be best off remaining as LLCs. That’s because LLCs are simple enough that adding a corporate status might needlessly complicate things. 

As your business grows, an LLC still may be best if you’re not planning to sell stock or seek angel investor funding or venture capital. Otherwise, an S corp may be better, as it often is for any large, complex company.


Read our reviews of the best business loans to learn how to obtain non-investment funding for an LLC. Or, read our in-depth Rapid Finance review, our top choice for fast funding.

Can you switch between an LLC and an S corp?

Yes, you can switch between an LLC and an S corp. In fact, your business can be both at once; the two are not mutually exclusive. 

Filing for S corp status at the federal level in no way eliminates your state-level LLC status. You can even revoke your S corp status after you elect to file taxes under this classification. However, this requires more paperwork, so try to make decisions you’re unlikely to reverse.

What certificates are required for an LLC and an S corp?

To understand LLCs and S corps, it helps to learn about C corporations. Taxed under Subchapter C, C corps are separate taxable entities that file Form 1120. You can convert an LLC or a C corp into an S corp by filing Form 2553 with the IRS, as long as the business meets all Subchapter S guidelines.  

LLCs require business owners to file with the state where the LLC was formed, and these requirements may vary by state, according to Brian Cairns, CEO of ProStrategix Consulting. 

“Most states require some public notification, which can be costly depending on the jurisdiction,” Cairns said. “For example, in New York state, you have to advertise in the county in which the LLC is formed. If you form in one of the five boroughs of NYC, this can cost upward of $1,000.” 

For S corps, you’ll need to file articles of incorporation in the state where you want to incorporate. An annual shareholder meeting and additional state reporting are also required. 

Should I have my LLC taxed as an S corp?

The right structure for your business depends on you, other owners and the business itself, but you should be aware of the benefits and drawbacks of having your LLC taxed as an S corp. 

Having your LLC taxed as an S corp includes these upsides: 

  • The business pays your salary and its payroll taxes. This may save you money on taxes because, as with a regular LLC, you would pay self-employment taxes on the business’s gross income.
  • Additional earnings are distributed to shareholders as dividends. This may also save you money, since dividends are taxed at a lower rate than income is. 

Having your LLC taxed as an S corp includes these downsides:

  • There’s a salary cap. You must establish reasonable compensation for owner-employees.
  • There are limitations. You’re limited to one class of stock and 100 shareholders.
  • Shareholder restrictions. Shareholders own more than 2% of the company’s stock and can’t claim employee health insurance as a tax-free benefit as they could with a C corp. 

Having your LLC taxed as an S corp once you hit the $60,000-a-year mark is a great decision, according to Scott Royal Smith, founder and CEO of Royal Legal Solutions. 

“This allows you to divide the income between personal income and dividend income and gets you to a lower overall tax rate,” Smith said. “The drawback is that you also have to pay for an individual S corporation tax return at that point. You have to weigh the tax savings in what you’re keeping from the government against how much the CPA is going to charge you.” 

Smith believes the $60,000 annual mark is usually where that plays out. Before then, it’s best to accept the money as personal income and file Form 1040 on your personal return.  

Can an LLC purchase a membership interest in an S corp?

Generally, no, but there are loopholes in business and finance. The ownership stake of an LLC member is called a membership interest, and owners of an S corp are called shareholders. 

Shares or stock represent a shareholder’s interest in a corporation. In the event the corporation does not issue stock certificates and only documents the number of shares distributed on paper, an LLC that wants an ownership interest in an S corp would purchase shares, not a membership interest. 

An LLC with more than one member can’t purchase or own S corp stock because it violates Subchapter S guidelines. However, a single-member LLC taxed as a disregarded entity could own S corp stock, which is uncommon. 

Starting your LLC vs. S corp journey

Many entrepreneurs set up their new ventures as LLCs to have some legal protection for their personal assets. However, when your business grows, it’s a good idea to speak with your CPA and look into filing as an S corp for the financial benefits. To follow the proper guidelines under your state’s laws, you should also determine how many investors, stock classes and foreign owners will be members of your LLC.

Max Freedman and Joshua Stowers contributed to the reporting and writing in this article. Some source interviews were conducted for a previous version of this article.

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Simone Johnson, Business Strategy Insider and Senior Writer
Simone Johnson advises small business owners on the services and resources needed for not only day-to-day operations but also long-term profitability and growth. She's long had an interest in finance and has studied economic trends affecting the financial landscape, including the stock market. With this expertise, Johnson provides useful instruction on everything from EBITDA to payroll forms. In recent years, Johnson has expanded her purview to include advertising technology and digital marketing strategies. She has spent significant time profiling entrepreneurs and helps companies with brand objectives and audience targeting. Johnson holds a bachelor's degree in communications and a master's in journalism.
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