What’s the difference between an LLC and S corp?   S corporations and LLC’s are similar in both the way they provide liability protection to the owners and in the way they report taxes. 

Both provide limited liability protection to the business owners.  This means that if the business gets sued and a judgment is obtained against the business, the judgment creditor can only go after the assets of the business and not the individual’s personal assets.  However, liability protection is not absolute  and often is determined  on the facts of each situation. 

It has been suggested  that the liability treatment of S corporations (which are treated just like regular C corporations for liability purposes) is more predictable than LLC’s because they have been available for many more years than LLC’s and have a lot more legal cases which act as precedents in determining issues of liability.  However, we are seeing more and more cases involving LLC’s so this distinction difference is not as important as it might have been in the past. 

Both S corporations and LLC’s are pass-through entities for tax purposes.  That means the  entities file an informational tax return and report the net profits of the business.  However, the individual owners, which are called shareholders in an S corporation and members in an LLC, report income and/or losses on their individual tax returns based upon their prorata share of ownership.  For example, if there are two members in an LLC with one owning 25% and the other 75%, then the one would report and pay income tax on 25% of the net income of the LLC and the other would report and pay income tax on 75%.  

There are some differences in the way basis  is determined for the purpose of determining losses.  Basis is a complicated tax concept to discuss  with your tax advisor.  Just keep in mind that if you are expecting substantial losses in the early stages of the business or if you are borrowing substantial sums of money for your business, the LLC may allow you to deduct greater losses than you could if operating the business as an S corporation.

Some accountants  recommend using the S corporation to reduce (not eliminate the 15.3% FICA or self employment tax).  This advantage  use to favor S corps in many situations.  However, LLC’s can now choose  S corp tax treatment so a person can operate an LLC with the less rigid operating requirements of an LLC but get the same or similar tax treatment of an S corp.  I believe this is a good approach to discuss with your tax advisor.