S Corporation vs LLC: Which is better for your small business?

When you’re starting a small business, one of the first big decisions you’ll face is choosing a legal structure. The right choice will affect everything from legal protections to how you pay federal taxes, as well as how much paperwork you’ll have to deal with each year.

There are numerous business structures you can choose from in the US, but two of the most popular options are a Limited Liability Company and an S Corporation.

At first glance, they might seem similar; both offer liability protection and pass-through taxation. But the differences between them can have a big impact on your business’s long-term success.

In this in-depth guide, we’ll walk you through everything you need to know about S Corporations and Limited Liability Companies, so you can make an informed decision on what's best for your business.

What is a Limited Liability Company (LLC)?

A Limited Liability Company (LLC) is one of the simplest and most flexible business structures available to entrepreneurs. It combines elements of sole proprietorships, partnerships, and corporations, making it a popular choice for freelancers, small teams, and growing businesses.

The key features of an LLC include:

• Liability protection: Your personal assets (like your home or savings) are shielded from business debts and lawsuits, as long as you keep your business and personal finances separate.
• Flexible ownership: An LLC can have one owner (i.e., a single-member LLC) or multiple owners (i.e., a multi-member LLC). Instead of shares, owners hold membership interests that define their rights and profit distributions.
• Taxation: By default, LLCs are taxed as pass-through entities. This means profits are reported on your personal tax return, avoiding double taxation. You can deduct ordinary and necessary business expenses. LLCs may also elect to be taxed as an S Corporation or C Corporation for potential tax advantages.
• Management options: LLCs don’t require a board of directors or officers. They can be managed directly by members or by appointed managers.

LLCs are generally easier and less expensive to maintain than corporations, which makes them appealing to first-time business owners who want simplicity without giving up liability protection.

Learn more: What is an LLC, and what are the benefits of setting one up?

What is an S Corporation?

An S corporation isn’t actually a type of business entity; instead, it’s a tax classification under federal tax law that eligible LLCs and corporations can choose with the Internal Revenue Service. The “S” stands for “Subchapter S” of the Internal Revenue Code, which governs how these businesses are taxed.

Learn more: What is an S Corporation?

To qualify for this tax classification, your business must:

• Be a US-based LLC or corporation
• Have no more than 100 shareholders
• Ensure that all shareholders are US citizens or residents

Like LLCs, S Corps offer liability protection, shielding your personal assets from your business obligations.

Note that to activate this status, business owners must meet specific Internal Revenue Service filing requirements, including filing Form 2553 by the deadline (see further down).

Key differences between LLCs and S Corporations:

What are the differences in taxation?

The most significant distinction between an LLC and an S Corporation lies in how they’re taxed.

How are LLCs taxed?

By default, single-member LLCs are taxed like sole proprietorships, and multi-member LLCs are taxed like partnerships. All profits “pass through” to the members’ personal tax returns, and members pay self-employment taxes (i.e., Social Security and Medicare) on their share of the income.

LLCs also have the option to elect S Corporation or C Corporation taxation if it benefits them.

Learn more: What are the tax benefits of setting up an LLC?

How are S Corporations taxed?

S Corporations are also pass-through entities, but with one big advantage: owners can divide income into two parts:

1. Salary: The salary is paid to the owner as a business expense, and subject to payroll taxes.
2. Distributions: Profits are paid out beyond the salary, but not subject to self-employment tax.

As a business owner, this setup can significantly reduce your overall tax liability if you're earning higher profits. However, the IRS requires that salaries be “reasonable,” and compliance costs (like running payroll) can offset some of the tax benefits for very small businesses.

This treatment, defined under Subchapter S, allows business owners to reduce their self-employment tax burden while still complying with federal tax law.

What about C Corporations?

A C Corporation (or C Corps) is the default corporate structure in the US. Unlike LLCs and S Corporations, C Corps are subject to double taxation, which means the corporation pays at corporate tax rates, and your shareholders pay income taxes again on dividends.

The key features of a C Corp include:

• Strong liability protection.
• Unlimited shareholders, including foreign owners and other entities.
• The ability to issue multiple classes of stock (which is important for venture capital).
• Strict governance requirements (board of directors, bylaws, regular filings).

Most small businesses don’t start as C Corp because of the complexity and tax burden. But they’re often the right choice for companies that are planning to raise money from venture capital investors, go public, or reinvest most profits back into the business.

C Corps are usually the best choice for businesses that want to raise venture capital, go public, or reinvest profits for growth. For most small businesses, however, LLCs or S Corps are simpler and offer more immediate tax benefits.

Learn more: What is a C Corporation?

What about liability protection?

As discussed, one of the main reasons entrepreneurs form an LLC or elect for S Corporation status is to separate their personal assets from their business liabilities. In both cases, the business is treated as a separate legal entity, which means that if your company is sued or takes on debt, your personal assets (like your house, car, or personal savings) are generally protected.

This covers:

• Debt and obligations: If your LLC or S Corporation takes out a loan or owes money to vendors, you personally aren’t responsible for paying it back (unless you’ve personally guaranteed the loan).
• Lawsuits: If a customer, employee, or partner sues your business, liability is limited to the business’s assets.
• Separation of business entities: Both structures draw a clear line between “you” and “the business,” which shields your personal life from business risks.

This protection is often what makes LLCs and S Corporations more appealing than sole proprietorships or partnerships, where business owners are personally liable for everything.

However, it’s important to understand that liability protection is not absolute. Courts can “pierce the corporate veil” and hold you personally responsible if you don’t follow certain rules or make common mistakes, such as:

• Commingling funds: Mixing business and personal expenses in the same bank account.
• Undercapitalization: Starting the company without enough money to reasonably operate, making it look like a shell entity.
• Failure to follow formalities: For S Corporations in particular, not holding required meetings or keeping records.
• Fraud or illegal activity: Protection disappears if you knowingly commit fraud or engage in unlawful business practices.

While both LLCS and S Corporations offer limited liability, there are some differences worth noting. With an LLC, protection is strong but less tied to formal requirements. As long as you keep your finances separate and act in good faith, liability protection usually holds.

With an S Corporation, protection is equally strong, but because corporations are more tightly regulated, owners must follow more formalities (such as board meetings, minutes, and resolutions). Failing to do so can give creditors or plaintiffs an argument to reach your personal assets.

What are the other main differences?

Other differences include:

Ownership and management

One of the main advantages of an LLC is the flexibility in ownership and management. For instance, you can benefit from:

• No ownership limits: As mentioned, an LLC can have one member (i.e., a single-member LLC) or multiple members (i.e., a multi-member LLC). This makes LLCs especially attractive to startups with international partners, or businesses with complex ownership structures.
• Management options: LLCs can be member-managed (i.e., the owners handle daily operations), or manager-managed (i.e., the owners appoint someone else to run the business). This flexibility allows you to decide how hands-on you want to be.
• Profit distribution: LLCs don’t have to distribute profits in proportion to ownership percentages. For example, two owners with a 60/40 ownership split could agree to split profits 50/50, if their operating agreement allows.

This flexibility makes LLCs appealing to entrepreneurs who want control over how their business operates and how profits are shared.

However, S Corporations operate under stricter rules, set by the IRS and state laws. These include:

• Ownership restrictions: As mentioned, an S Corporation can have no more than 100 shareholders, and they must all be US citizens or residents. It cannot be owned by other corporations, LLCs, or partnerships.
• One class of stock: All shares must have equal rights to distributions and voting. This means you can’t create different stock classes to allocate profits or control unevenly.
• Management structure: S Corporations must have a board of directors to oversee high-level decisions and corporate officers (such as a president or treasurer) to handle daily operations. Even if you’re a one-person S Corporation, you technically wear all these hats.

That said, while the structure is more rigid, it also adds credibility with banks, investors, and potential partners who may prefer working with corporations.

Compliance and administration

One of the biggest appeals of an LLC is that it requires minimal compliance. This means:

• Annual filings: Most states require a simple annual (or biennial) report and a filing fee.
• Few formalities: LLCs don’t need to hold annual meetings or record minutes, although you must appoint a registered agent to receive legal and tax documents.
• Operating agreements: These are not always required, but are strongly recommended to set rules for ownership, management, and profit distribution.

This simplicity makes LLCs ideal for entrepreneurs who don’t want to spend valuable time managing paperwork.

Learn more: How do you set up payroll as an LLC?

Conversely, S Corporations come with more red tape. There are:

• Annual meetings: Shareholders and directors must meet at least once a year.
• Meeting minutes: These must be recorded and stored as part of corporate records.
• Bylaws: S Corporations must adopt and follow bylaws that set governance rules.
• Payroll obligations: If you receive an owner's salary (required by the IRS), your payroll taxes must be withheld and remitted.
• Additional filings: Depending on your state, S Corporations may need to file separate reports beyond federal requirements.

This added structure can be beneficial for accountability, but it also means higher ongoing costs for legal, payroll, and accounting support.

Flexibility and scalability

LLCs are designed to adapt as businesses grow, which means:

• Flexible ownership: You can add new members, change profit-sharing arrangements, or restructure management as your business evolves.
• Adaptable taxation: You can start with default pass-through taxation, then elect for S Corporation status later (if it becomes financially advantageous).
• Lower workload: Freelancers, consultants, and small teams often benefit from the simplicity and low administrative load.

However, LLCs may face challenges when scaling significantly. Investors, especially venture capital firms, often prefer corporations because of their stock structure and familiarity.

In fact, while S Corporations are more rigid, this structure can make them a good fit for businesses with steady income and long-term growth plans. This includes:

• Tax efficiency at scale: Once your business reaches consistent profitability, the ability to save on self-employment taxes through salary and distributions becomes valuable.
• Credibility: Banks and investors may view S Corporations as more formal and reliable, particularly compared to single-member LLCs.
• Limits on growth: The ownership restrictions (i.e., 100 shareholders, all US residents) mean S Corporations aren’t suitable for businesses planning to raise large amounts of capital or expand internationally.
  
  

How to decide between an S Corporation and an LLC

Choosing between an LLC and an S corporation isn’t just about checking boxes; it’s about aligning your business goals, income expectations, and risk tolerance with the structure that supports them best.

When making your decision, consider the following key factors:

1. Your expected profit level

If you’re just starting out and don’t expect high profits right away, an LLC usually makes the most sense. It’s simple, inexpensive, and flexible.

However, if your business is already generating steady profits (typically $70,000 to $100,000 or more per year), an S Corp election may help reduce your tax burden.

2. Administrative capacity

LLCs have minimal paperwork. If you’re a solo entrepreneur or don’t have accounting support, this may be more manageable.

S Corporations require payroll, recorded meetings, and stricter recordkeeping. If you can afford an accountant or payroll provider, compliance becomes less of a headache.

3. Ownership needs

LLCs allow unlimited flexibility in ownership. Members can be individuals, corporations, or even foreign entities.

S Corporations restrict ownership to 100 US citizens or residents, and everyone must hold the same type of stock.

4. Growth and investment plans

LLCs are excellent for small businesses that want to grow organically or keep ownership tight.

If you’re planning to bring in outside investors, you may need to think ahead. While S Corporations are more structured, they still have restrictions that may not work for startups seeking venture capital. In those cases, a C Corporation might be better.

To help illustrate, here are some examples:

• You're a freelancer or consultant making $60,000 per year. In this case, an LLC is likely the better choice. It’s simple, inexpensive, and protects your personal assets without adding unnecessary compliance costs.
• You're a small business with $200,000 in annual profit. An S Corporation election could save thousands in self-employment taxes by paying the owner a reasonable salary and taking the rest as distributions.
• You're a startup with international co-founders. Even though you may be making high levels of profit, an LLC is the more viable option since S Corporations limit ownership to US citizens and residents.

This is why it's often recommended to start simple with an LLC, and consider electing S Corporation status once your business is profitable enough to justify the extra compliance.

How to Form an LLC or S Corporation

The process for forming each structure varies by state, but here’s a step-by-step overview to help you understand what’s involved.

Forming an LLC

1. Choose a name. Check your state’s business registry to ensure the name is available and complies with local naming rules (e.g., must include “LLC” or “Limited Liability Company”).
2. File the Articles of Organization. Submit this document to your state’s Secretary of State (or equivalent agency). Filing fees typically range from $50 to $500.
3. Create an Operating Agreement. As mentioned, this is not always required, but it is strongly recommended. This internal document defines ownership percentages, management roles, and profit distribution, saving you from potential disputes down the line.
4. Get an EIN. If you don't already have one, apply for an Employer Identification Number (EIN) from the IRS. You’ll need this to open a business bank account and file taxes.
5. Register for state taxes and licenses. Depending on your state and industry, you may need sales tax permits, professional licenses, or other registrations.
6. Maintain compliance. File annual (or biennial) reports and pay any required state fees to keep your LLC in good standing.

You will need to pay formation fees plus a small annual report fee, although accounting costs are relatively low.

Forming an S Corporation

1. Start with an entity. You must first form either an LLC or a corporation at the state level.
2. Elect S Corp status. You’ll need to file Articles of Incorporation with your state’s Secretary of State before electing S Corp status with the Internal Revenue Service. You can then File Form 2553 with the IRS, signed by all shareholders. This must usually be filed within two months and 15 days after the start of the tax year that you want S Corp status to take effect.
3. Set up payroll. S Corp owners who work in the business must pay themselves a “reasonable salary.” This requires running payroll and withholding payroll taxes.
4. Adopt corporate bylaws. For corporations electing S Corp status, bylaws set the rules for governance. LLCs should update their operating agreements to reflect S Corp taxation.
5. Hold meetings and keep records. Schedule annual meetings of directors and shareholders, record minutes, and keep them on file.
6. Stay compliant. File annual state reports, issue W-2 forms for salaries, and ensure IRS deadlines are met.

You will also need to pay formation fees and the annual report fee, as well as payroll processing costs, potential bookkeeping software, and accountant fees for handling more complex filings.

How can Remote help?

The process of choosing between an LLC and an S Corp depends on your priorities. If you want simplicity and flexibility, an LLC might be the best fit. But if you’re focused on tax savings and are willing to take on extra administrative work, an S Corporation offers clear advantages.

This is where Remote can help. Our Payroll platform takes on that administrative work for you, making it quick and easy to ensure that you are fully compliant with all payroll tax and employment laws. We handle all the filing and reporting, leaving you to focus on running and growing your business — whichever model you choose.

Learn more about how Remote Payroll can help you stay compliant and make running your business easier.