For business startups, entity formation is one of the most critical decisions. It is important to choose the right entity so your company can accomplish its goals and minimize tax liability. For many small businesses, the decision often comes down to a limited liability company (LLC) vs a Subchapter S Corporation (S-Corp). The main differences between the two are in ownership structure, the way each is managed and taxes.

Ownership: An owner of an LLC is referred to as a “member” while an owner of an S-Corp is referred to as a “shareholder.” When it comes to ownership, there is far greater flexibility with an LLC than with an S-Corp. S-Corps have limitations that are not present with LLCs, including:

• Limited Number of Owners: S-Corps are limited to only 100 shareholders while LLCs are allowed to have an unlimited number of members.

• Restrictions on who can be an Owner: Non-U.S. citizens/residents are not allowed to be shareholders in a Subchapter S Corp. The same holds true for other S-Corps, LLCs, C-Corporations, and most trusts. There are no such restrictions on LLCs.

S-Corps are also required to adopt several formalities that are optional (and often recommended) but not mandatory with LLCs. These include:

• Issuance of stock
• Adoption of corporate by-laws
• Holding director and shareholder meetings on an annual basis
• Keeping minutes of these annual meetings

Management: There are important differences in the way S-Corps are managed compared with LLCs. The management structure of an S-Corp is similar to that of a C-Corp. Shareholders elect a board of directors. The board of directors in turn appoints officers to run the company. Unless a shareholder is also a director and/or company officer, he/she has no input into how the company is run.

LLCs have two management structure options: member-managed and manager-managed. In member-managed LLCs, the owners also run the company, making it similar to a partnership. In manager-managed LLCs, the members appoint managers to run the company, making it more like a corporation. One reason many LLCs choose the manager-managed option is privacy; only the names and addresses of the managers must be listed on the corporate documents, meaning owners/members who are not also managers can keep their names private.

Taxes: There are many similarities and a few differences between the ways LLCs and S-Corps are taxed. The major advantage with both is they are “pass-through” entities. This means the profits and losses of the company are not taxed at the corporate level but are passed directly to the owners. This allows the company to avoid double-taxation, a common problem C-Corporations have.

One benefit to S-Corporations is with self-employment taxes. The owner of an S-Corp can be an employee and be paid a reasonable salary. All profits earned beyond that salary can be taken as dividends, thus allowing the owner to avoid self-employment taxes on these monies. LLCs have more complex rules regarding self-employment taxes. In general, if a member is also a manager or employee of the company, he/she is required to pay self-employment taxes on profit distributions.

Deciding between an LLC vs. S-Corp for your business can be difficult, and the ownership, management, and tax implications of each are major considerations. For specific guidance on the right entity structure for your business, it is best to speak with a local tax professional.