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Choosing the Right Business Structure

LLC or S corporation? We'll help you figure out the differences.

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Q:What's the difference between an S corporation and an LLC? How do I select the proper business structure?

A: Of all the decisions you make when starting a business, the most important one is probably the type of legal structure you select for your company. Not only will this decision have an impact on how much you pay in taxes, but it will also affect the amount of paperwork your business is required to do, the personal liability you face and your ability to raise money. Let's take a look at two common forms of business structures, a subchapter S corporation and a limited liability company, to see how they stack up against each other.

Subchapter S corporations, also known as just S corporations, and LLCs possess several similarities: They offer their owners limited liability protection, and both are pass-through tax entities. Pass-through taxation allows the income or loss generated by the business to be reflected on the personal income tax returns of the owners. This special tax status eliminates any possibility of double taxation for S corporations and LLCs.

That's where the similarities end. The owner-ship of an S corporation is restricted to no more than 75 shareholders, whereas an LLC can have an unlimited number of members (or owners). And an S corporation can't have non-U.S. citizens as shareholders, but an LLC can. In addition, S corporations cannot be owned by C corporations, other S corporations, many trusts, LLCs or partnerships. LLCs, on the other hand, are not subject to these ownership restrictions.

S corporations aren't without their advantages, however. One person can form an S corporation, while in a few states at least two people are required to form an LLC. Existence is perpetual for S corporations. Conversely, LLCs typically have limited life spans.

A few other advantages of S corporations: Their stock is freely transferable, but the interest (ownership) of LLCs is not. This free transferability of interest means the shareholders of S corporations are able to sell their interest without obtaining the approval of the other shareholders. In contrast, LLC members would need the approval of the other members to sell their interest. Lastly, in comparison to LLCs, S corporations may be beneficial in terms of self-employment taxes.

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