A Quick Look at Other Business Entity Choices
Before narrowing in on LLCs and S corporations specifically, it helps to see the full landscape of business structures our team commonly works with.
Sole proprietorship is the simplest structure available. You report business income directly on your personal return using Schedule C, and there’s no separate business filing required. The downside is that you carry personal liability for every business debt and lawsuit, and all your income is subject to self-employment tax.
C corporation structures suit certain larger businesses or those seeking outside investors, but they rarely make sense for small, closely held businesses. A C corp pays tax at the corporate level, and then shareholders pay tax again on any dividends distributed. Even with favorable rates on qualified dividends, that double taxation usually outweighs the benefits for a smaller business.
Limited liability partnership (LLP) offers liability protection similar to an LLC, but within a partnership structure. Each partner is generally shielded from personal liability for the business’s debts and, most importantly, from malpractice or negligence of the other partners.
For most small business owners, the real decision comes down to an LLC or an S corporation, since both offer liability protection and pass-through taxation.
What an S Corporation Actually Is
An S corporation isn’t a separate business entity — it’s a tax election available to qualifying corporations and LLCs. Once elected, the business generally doesn’t pay federal income tax itself. Profits and losses pass through directly to your personal return instead.
Legally, an S corporation is still a corporation under state law. The election only changes how the IRS taxes the business. That distinction matters if you ever want to unwind the election, since converting from an S corporation back to an LLC often means liquidating the corporation, which could trigger a taxable gain.
Our team covers the full mechanics of this election, including the reasonable salary requirement and the self-employment tax savings, in our guide on electing to be taxed as an S corporation.
What an LLC Actually Is
The LLC has become the default choice for a huge share of small businesses, and for good reason. By default, a single-member LLC gets taxed as a sole proprietorship, and a multi-member LLC gets taxed as a partnership. Like an S corp, an LLC generally provides pass-through taxation while shielding your personal assets from business liabilities.
An LLC is not a tax strategy, rather it is legal liability protection. The LLC, however, gives you a path to change your tax treatment later without changing your legal structure. You can elect S corporation tax treatment by filing IRS Form 2553 without touching your underlying LLC formation.
How Forming Each Entity Structure Actually Works
Forming an S corporation generally requires filing Articles of Organization or Incorporation, preparing corporate organizational documents, issuing stock, and filing Form 2553 with the IRS. Licensed professionals sometimes organize as a Professional Corporation (PC) instead, depending on state requirements.
Forming an LLC typically involves filing Articles of Organization, drafting an Operating Agreement, and registering with your state. Certain licensed professionals may need to form a Professional LLC (PLLC) rather than a standard LLC.
Key Differences Between an LLC and an S Corporation
Ownership Rules
An S corporation limits you to 100 shareholders, restricts ownership to U.S. individuals, certain trusts, and estates, and permits only one class of stock. An LLC has no cap on the number of owners, allows a much broader range of ownership types including corporations and partnerships, and offers far more flexibility in how ownership percentages get structured.
Self-Employment Taxes
This is usually the deciding factor for our clients. In an S corporation, owners who work in the business receive a salary subject to payroll taxes, and any additional profit distributed beyond that salary generally avoids self-employment tax. In a standard LLC without an S corp election, business income allocated to active members is generally subject to self-employment tax in full. We break this down in more detail in our post on what self-employment taxes actually are.
Tax Basis
Tax basis determines how much of a business loss you can deduct and affects how future distributions get taxed. S corporation basis includes cash and property contributions, undistributed profits, and any loans you personally make to the business. LLC basis includes all of that, plus your share of the LLC’s liabilities and any business debt you’ve personally guaranteed. Because LLC owners get basis credit from entity-level liabilities, they often end up with a higher tax basis than S corporation shareholders in a comparable situation.
So, Which One Should You Choose?
For many new businesses, starting as an LLC makes the most sense. It’s flexible, it carries fewer ownership restrictions, and it preserves your ability to elect S corporation taxation later if your profit grows enough to justify it. You’re not locking yourself into a structure before you know how the business will actually perform.
That said, once a business generates consistent, meaningful profit, electing S corporation tax treatment often becomes the better move, primarily for the self-employment tax savings.
The right answer for your business depends on a handful of factors our team walks through with every client:
- Expected annual profit
- Number of owners
- Whether you’re planning to bring on investors
- Payroll considerations and administrative capacity
- Long-term tax planning goals
How Our Team Helps You Decide
Choosing the wrong structure can mean paying more in taxes than necessary, carrying more liability than you need to, or facing a costly restructuring down the road. Our business advisory services are built specifically to help you evaluate LLCs, S corporations, partnerships, and C corporations against your actual numbers and goals.
Once your structure is in place, our team keeps it working in your favor through ongoing tax planning and accurate monthly bookkeeping, so the entity you chose keeps paying off as your business grows.
Talk to Our Team Before You Choose
Working with an experienced CPA before you form your business, or before you make a structural change, gives you the best shot at choosing an entity that provides real legal protection and real tax advantages for your specific situation. Our team has helped Colorado business owners across make this decision with confidence. If you’re weighing an LLC against an S corporation, schedule a consultation with our team today.
