When you’re forming a new business, you’ve got a lot of choices on how to structure it. The most popular is the sole proprietorship, which entails using the Schedule C form on your personal tax return to report profits.
But a sole proprietorship doesn’t protect business owners assets and has other drawbacks. That’s why many small businesses consider forming S corporations (S corps) and Limited Liability Companies (LLCs). Both of these structures allow earnings to be “passed through” to your personal tax return.
However, I always recommend forming an LLC over an S corp. Here are seven reasons to choose an LLC for your business structure.
1. LLCs are taxed the same as S corps.
When you form an LLC, you’ll have the choice of being taxed just like any other “pass-through” business, including:
- S corps
- Partnerships
- Sole proprietorships
Assuming you choose an LLC, you’ll likely file the IRS Form 1065-Partnerships. Your profits will not be taxed at the company level and instead will “pass through” to your individual return. You will likely be able to take advantage of the Section 199A Qualified Business Income Deduction, which means that as much as 20% of your company’s income may not be subject to taxes.
2. LLCs are flexible and less expensive to operate
S corps are subject to corporate rules because they’re corporations. This means that if you form an S corp you will need to have a formal set of bylaws. You will also need a board of directors that will be required to regularly meet and produce written minutes. You don’t need these things with an LLC.
Instead, you’re only required to have an “operating agreement,” which can be as flexible as you need it to be.
3. You can have unlimited owners with an LLC.
An S corp can only have up to 100 shareholders, and they must be U.S. citizens or residents. An LLC can have as many “members” as you’d like and there’s no restrictions on nationality.
An LLC can be owned by other S corps, C Corporations, LLCs, business partnerships, or sole proprietorships, but an S corp cannot.
4. LLCs offer the same liability protection as S corps.
For both LLCs and S corps, your personal assets are protected. There’s no difference between the two. Of course, a skillful lawyer may find a way to pierce the veil, but the risk is the same with either type of organization.
5. It’s easy to raise money as an LLC.
There is this myth that it’s easier to get financing if you’re an S corp versus an LLC. Maybe that was the case years ago, but I don’t see it anymore.
If you’re a profitable small business with a reliable forecasted debt maintenance plan, you’ll get the same interest from a bank regardless of your corporate structure. Most of the time banks will still require personal guarantees, too. If you’re seeking outside investors that want a more “corporate” structure, such as having a board, bylaws and other required documentation, that can be part of your LLC’s operating agreement.
6. Converting to a corporation isn’t difficult.
If an investor prefers that your company be an “Inc.” instead of an “LLC”, that’s doable.
Converting an LLC generally requires you to file a certificate of conversion. You’ll need to submit other documents both to the IRS and your state. There’s also a filing fee. While you may incur some accounting and legal fees, you won’t have to form a whole new entity or dissolve your existing LLC.
7. Having “Inc.” after your business’s title isn’t as important as it used to be.
Back in the day, having a company with an “Inc.” after its name had some sway. But in 2023, it’s now common to run into all-virtual companies or companies with a “.io” web address. It’s also common to see companies that identify themselves as LLC instead of Inc.
Some of this information may be different for your state, so please review my suggestions with an experienced accountant. Regardless, my recommendation is to use an LLC over an S corp for your business. To me, it makes sense to go the LLC route. It gives you the most flexibility and protection. And if you want to go all-corporate someday, it’s easy to do so.
Additional Resources
To learn more about this topic, you can read through additional resources from the Internal Revenue Service (IRS), below:
- https://www.irs.gov/businesses/small-businesses-self-employed/limited-liability-company-llc
- https://www.irs.gov/businesses/small-businesses-self-employed/llc-filing-as-a-corporation-or-partnership
- https://www.irs.gov/pub/irs-tege/llc_guide_sheet_instructions.pdf
- https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations
- https://www.irs.gov/pub/irs-prior/p589–1995.pdf
*This article is a high level comparison of these two types of corporate organizations that doesn’t take into consideration local requirements and the specifics of individual businesses. If you’re considering a change in structure you should work closely with your legal and financial advisors.
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View Comments (46)
It's true nowadays, LLC are more popular among social media influencers.
LLC's aren't taxed at all - they are meaningless from a tax standpoint, since all LLC's MUST file as an S-corp, sole prop or partnership and that entity is what gets taxed, not the LLC. So they are NOT taxed the same as an S-corp (unless the LLC files as an S-corp).
Sole Props, Partnerships and S-corps all may qualify for the 20% QBID deduction. But only S-corp shareholders are exempt from the 15.3% self-employment tax sole props and partners must pay on 100% of the pass-thru income. That's a significant tax savings!
As far as number of owners, LLC's can't have "unlimited" members unless they are filing as a partnership and the partnership agreement allows unlimited members. Otherwise they have ONE member (the sole proprietor) or up to 100 shareholders (under an s-corp).
ALL LLC's must be S-corps, partnerships or sole props. Sole props and partners may be able to avoid personal liability by adding an LLC veneer (which should be weighed against the simplicity, and often lower cost, of an umbrella policy).
I have an S-Corp established in 1992 and LLC (S-Corp status) established in 2012. Everyone has commented and stated the taxation differences.
Most important is to document and maximize expenses to keep your tax liability low.
And... imagine being a top 10%'er or elected Fed level politician where you have dozens of LLC and S-Corps to bury personal benefits as business expenses.
Thank you for sharing, Andy!
Nice short article. How does one go about becoming a LLC?
That’s a complicated question that is outside of the scope of this article. It will depend on a lot of factors and should be discussed with your accountant.
Good Article. What is the difference between S and C corporations?
We're glad you liked it, Lisa! You can read more about C and S Corps in the articles below:
https://www.thehartford.com/business-insurance/strategy/business-structure/s-corporations
https://www.thehartford.com/business-insurance/strategy/business-structure/c-corporations
This was very helpful. I now have a S Corp with the only members being my son & myself. I'm thinking that maybe I should convert to a LLC. What do you think?
Quite possible but it depends on a lot of factors specific to your business (s) and where you’re located. I suggest you go over the process with a tax advisor.
You left out one huge advantage of an "S" corp over an LLC. I am a one person S corp, and was previously an LLC
In an LLC, every $ is subject to Social security taxes. With an S corp, you pay yourself a salary, and the related SS taxes on that salary. The remaining profits are not subject to SS taxes, and can be taken as a distribution as desired.
"You will likely be able to take advantage of the Section 199A Qualified Business Income Deduction, which means that as much as 20% of your company’s income may not be subject to taxes." You fail to mention that an S corp also receives this benefit.
Granted, my accounting costs are higher due to the more complex tax filing requirements; (about 1k/yr), but it more than offset by the SS savings of 12K+/yr.
Try running the taxes for 2 businesses; both with 150k in profits as an LLC, and as an S corp with the owner paying himself a 75k salary. I think you will find it an eye opener.
On the SS taxes, that is a great point and specific to you – and others – that may be a single-owned company. If that applies to your business then Regarding the QBI deduction as both LLCs and S-Corps are pass-through they share many features of a pass through entity, including the ability to take advantage of this great deduction (which unfortunately may expire after 2025). Thanks for reminding our readers.
This analysis doesn't include the fact that a S-Corp offers the owners to pay themselves a reasonable salary and then the remaining net business income is not subject to payroll taxes.
Also, how are partnerships less expensive to operate than a S-Corp? Both require legal documents and separate tax returns.
Sole proprietors and S-Corp single owner-employees have the option to open a solo 401k to save for retirement and a possible greater contribution amount than a SEP IRA.
The article starts out discussing sole proprietors and then assumes that they get additional partners in order to form a partnership. What is the recommendation is the sole proprietor has no partners - what is the best option then?
S-Corps do offer this benefit but so may other pass-throughs like LLCs depending on your situation.
Partnerships can be less expensive depending on the number of partners/shareholders involved.
Thanks for mentioning the solo 401K options- that’s another great topic to explore for all entities as there are many 401k, IRA and SEP options for business owners.
Sorry but your first reason is grossly overstated. 100% of net income earned by a General Partner in a Partnership is subject to income tax and self-employment tax. In a S Corporation, only the W2 payments to the S Corp shareholders is subject to self employment tax. The definition of "reasonable compensation" has never been defined by statue. Thus, in most cases if a Shareholder pays themselves 60% of the net income through W2 wages, the balance of the net income can flow through to the taxpayer tax free of self employment taxes. Yes, it will reduce their future benefit (if it even will exist) but for someone who has put in 20 years plus in a W2 position prior to starting their own business, they need to understand the ramifications of the above as part of the decision process.
The issue I have with this article is an s-Corp does have the main benefit of tax saving on self employment tax after you pay a reasonable salary to yourself.
That may also be the case with other pass-throughs and depends on the specific situation of the business owner. SS taxes may not be due if the partner isn’t active. There are many variables. But your point is very valid and each business owner should discuss their personal details with their accountant.