Related reading: S corp vs LLC, our 2026 guide to the election itself, including the qualified business income offset and the reasonable salary rules.
Key takeaways:
An LLC is a business entity that is separate from its owners, providing personal asset protection. LLCs are typically taxed as pass-through entities.
An S Corp is a subtype of corporation that provides limited liability protection for its shareholders. Income, losses, deductions, and credits are transferred to S Corp shareholders.
For startups, the choice between an LLC and an S Corporation often depends on specific circumstances and long-term goals.
The basic structure of an LLC and an S Corporation
How does an LLC work?
To form an LLC, you must file Articles of Organization with the state in which the business will operate.
An LLC is a business entity that is separate by law from its owners, who are called 'members.' This legal separation provides personal asset protection. In other words, if the company has debt or liabilities, the members' personal assets are protected from business liabilities.
As far as members, LLCs can have a single or multiple members, each owning a percentage of the LLC. Members can be individuals, corporations, other LLCs, or foreign entities. Further, there's no limit to the number of members an LLC can have, providing flexibility for how the LLC is arranged.
As for taxes:
LLCs are typically taxed as pass-through entities. What that means is that the business doesn't pay taxes on its income; instead, the business' profits and losses are transferred to the individual members who report their share on their personal tax returns.
How does an S Corporation work?
An S Corporation is formed as a regular corporation and then electing S Corp status with the Internal Revenue Service (IRS). (You must file Form 2553).
Shareholders must be individuals, certain trusts and estates, or specific tax-exempt organizations. There can be no more than 100 shareholders. Partnerships, LLCs, and corporations cannot be shareholders.
An S Corp provides limited liability protection for its shareholders, meaning the shareholders' personal assets are generally protected from the company's debts and liabilities.
There are exceptions, though. When a shareholder personally commits a tort or engages in negligent behavior, they can be held personally liable for resulting damages.
Regarding taxes:
The corporation itself does not pay federal income tax. What happens instead is that the S Corp's income, losses, deductions, and credits are transferred to its shareholders. They report their share of these items on their personal tax returns and pay taxes at their individual income tax rates.
What LLCs and S corps actually have in common
Founders usually approach this as a binary between two opposite structures. It is not, and the framing causes real mistakes.
Before the differences, it is worth being precise about what these two things even are. This is where most comparison guides go wrong on the first page.
They are not the same category of thing
An LLC is a state-law entity. You form it by filing with a state, and it exists whether or not you ever think about federal tax.
An S corp is a federal tax election, made on Form 2553. It is not an entity type you can form at a state office.
Which means an LLC can elect S corp treatment and still be an LLC. The real comparison is between an LLC taxed under its default rules and a business taxed under Subchapter S, not between two rival company types.
Both are pass-through by default, but default is not guaranteed
Under default rules, both route business income to the owner's personal return, where it is taxed at individual rates with no federal tax at the entity level. That is what avoids the double taxation C corporations face.
Two caveats matter here.
First, an LLC that files Form 8832 to elect C corporation treatment is double-taxed like any other C corp. Pass-through is the default, not a property of the entity.
Second, avoiding double taxation is a federal statement only. California charges an $800 annual franchise tax plus a 1.5% tax on S corp net income. New York City does not recognize S corp status at all. Texas and Tennessee impose their own entity-level taxes.
So check your state before you treat pass-through status as a clean win. The federal answer and the total answer are often different.
Both provide limited liability protection
In both cases owners are generally shielded from personal liability for business debts and legal judgments. Your home, savings, and personal accounts sit behind that wall.
One clarification, since the election framing matters here too. Liability protection comes from the underlying entity, not from the S corp election. Electing S corp status does not add or subtract any protection.
Treat liability as a baseline both paths provide, not as a tiebreaker.
Both carry ongoing state compliance obligations
Neither structure lets you file once and forget it. Both face annual reports, state fees, and registered agent maintenance, and the state-level burden is broadly comparable.
The S corp side adds federal work, though. You file a separate Form 1120-S return, run payroll, and file the associated payroll returns. That administrative delta is a real cost, and it shows up in the math below.
What are the main differences between an LLC and an S Corporation?
Formation
Typically, LLCs are easier to form and maintain than S Corporations.
Why? That's because LLCs allow for more flexibility, specifically for its management structure and profit distribution.
S Corporations, on the other hand, have stricter requirements and formalities to follow.
Ownership
There are generally no restrictions on ownership for LLCs. In other words, LLCs can have an unlimited number of members. Members can be individuals, corporations, or other LLCs.
S Corporations have ownership rules that are more stringent. As mentioned earlier, they are limited to 100 shareholders.
Shareholders must be U.S. citizens or residents. Different from LLCs, however, S Corporations cannot be owned by other corporations, partnerships, or non-resident aliens.
Taxation
LLCs are typically taxed as pass-through entities by default, meaning the business itself doesn't pay taxes.
Instead, the LLC's profits and losses are transferred directly to the owners' personal tax returns.
Having said that, LLCs can choose their tax treatment, including being taxed as a corporation if desired.
As far as self-employment taxes, in most cases, all of an LLC member's share of profits is subject to self-employment taxes.
S Corporations are also pass-through entities for tax purposes.
However, S Corps have a unique tax advantage: shareholders who work for the company can receive both a salary and distributions.
Now, what makes this unique is that only the salary counts for self-employment taxes, which may affect overall tax liability. It's important to note that the IRS requires that shareholders receive a "reasonable salary" for their work.
Management structure
LLCs offer flexibility in management structure. They can be member-managed (where all owners participate in its management) or manager-managed (where designated managers run the company).
S Corporations, on the other hand, require a more formal management structure, with an official board of directors overseeing major decisions and officers managing the company's daily operations.
Profit distribution
A key difference is that LLCs have flexibility in how they distribute profits among members. This distribution doesn't have to be proportional to ownership percentages. For example, distribution can be based on the percentage each owns or they can be tied to each owners' performance results.
S Corporations must distribute profits to shareholders based on their ownership percentages.
How LLC vs. S corp taxes actually affect your take-home pay
Taxation is the most consequential difference between the two for most founders. It is also the one most guides explain with a number that is simply wrong.
The gap comes down to self-employment tax. Here is how it actually works.
The self-employment tax gap
LLC members active in the business pay self-employment tax: 12.4% for Social Security plus 2.9% for Medicare, or 15.3% combined.
But not on the full profit.
Self-employment tax applies to 92.35% of net earnings, not 100%. Almost every article that quotes a savings figure omits this, which overstates the tax by 23.6% and the apparent S corp benefit along with it.
There is a ceiling too. The 12.4% Social Security portion stops at the 2026 wage base of $184,500. Above that only the 2.9% Medicare portion continues, rising to 3.8% on earnings over $200,000 for single filers and $250,000 for joint filers.
An S corp owner-employee pays payroll taxes only on a reasonable salary. Profits distributed above that salary are not subject to self-employment tax, and that is the entire source of the savings.
A worked example at $150,000 of profit
Take a founder with $150,000 in net profit, and run both paths.
Single-member LLC | S corp election | |
Net earnings subject to tax | $150,000 × 0.9235 = $138,525 | $90,000 W-2 salary |
Social Security (12.4%) | $17,177 | included below |
Medicare (2.9%) | $4,017 | included below |
Total payroll or SE tax | $21,194 | $13,770 |
Treatment of the remainder | n/a | $60,000 distribution, no SE tax |
The saving is $7,424 per year, not the "over $9,000" figure that circulates widely. That larger number double-counts the 92.35% adjustment, because no such haircut applies to W-2 wages in the first place.
One more thing works in the LLC's favor. Half of the self-employment tax, roughly $10,597 here, is deductible above the line, which softens the gap further.
A worked example at $100,000, where it gets thin
Now run the same comparison at $100,000 in profit, splitting $60,000 as salary and $40,000 as a distribution.
As an LLC: $100,000 × 0.9235 × 15.3% = $14,130. As an S corp: 15.3% on a $60,000 salary = $9,180. The gross saving is $4,950, not the $6,120 usually quoted.
Then subtract what it costs to get it.
A payroll service, a separate Form 1120-S return, and higher preparation fees can absorb most of $4,950. S corp wages also reduce qualified business income, which shrinks the Section 199A deduction and claws back part of the benefit.
At this profit level the net gain can land near zero. Run your own numbers with a CPA before electing, rather than working from a headline percentage.
What this means for your financial setup
An S corp election only pays off if your bookkeeping keeps up with it. The salary and distribution split has to be documented, consistent, and defensible.
Distributions, operating expenses, and business accounts all feed that picture, and they need to be tracked in real time rather than reconstructed in April.
Founders who consolidate banking, corporate cards, bill pay, and expenses on one platform hand their accountant a cleaner data set at month-end and year-end. Rho's accounting integrations sync with QuickBooks Online, NetSuite, and Sage Intacct, so the transaction history your preparer needs is already mapped and categorized instead of assembled from spreadsheet exports.
LLC vs. S Corp's compliance and formality
The exact requirements of an LLC versus an S Corp can vary by state. It's a wise move to consult with a legal or tax professional to ensure full compliance.
So, what's the difference between an LLC and an S Corp's compliance and formality?
Well, LLCs have fewer formal requirements and offer more flexibility in management and record-keeping. The level of formality can often be determined by the members and outlined in the Operating Agreement, if the LLC decides to create one.
An S Corporation requires more rigorous adherence to corporate formalities, including regular shareholder meetings, detailed record-keeping, and strict compliance with bylaws and state corporation laws.
When to choose an LLC vs. S Corporation
The choice often depends on specific business circumstances, goals, and preferences.
Let's review simple scenarios where one might be better than the other.
Scenario 1: Simple startup
You're starting a small business with a friend and want a simple structure with minimal paperwork.
In this scenario, an LLC might be more attractive as LLCs offer flexibility and simplicity in management and operations, with fewer formal requirements than S Corporations.
Generally, LLCs are often better for smaller businesses, while S Corporations can be advantageous for larger or growing businesses.
Scenario 2: Startup that eventually wants to go public
Now, let's stick with the startup example from scenario 1.
Let's say that your goal is for your startup to eventually go public. In this case, an S Corporation may be more advantageous.
Why?
While S Corporations can't go public, the corporate structure may facilitate the transition to a C Corporation when the time is right.
Scenario 3: Foreign ownership
Let's say that you have non-U.S. citizens or residents who are co-owners of your business. Unlike S Corporations, LLCs don't have restrictions on the nationality or residency of owners, so choosing an LLC would make more sense in this scenario.
Scenario 4: Attracting outside investors
For this scenario, let's pretend you're planning to seek outside investment and want a structure that's familiar to investors.
In this case, the corporate structure of an S Corporation, with its clearly defined shares, can be more attractive to certain investors.
Advantages and disadvantages of LLCs and S Corporations for startups
| Entity Type | Advantages | Disadvantages |
| LLC |
|
|
| S Corporation |
|
|
Converting an LLC to an S Corp
Converting an LLC to an S Corp is a common trajectory for growing businesses that want to optimize their tax structure and prepare for future growth.
Let's review possible reasons for converting an LLC to an S Corp.
Tax savings: S Corps can potentially reduce self-employment taxes by allowing owners to receive both a salary and distributions.
Attracting investors: The corporate structure of an S Corp may be more attractive to certain investors.
Preparing for growth: S Corps can be better suited for businesses that are planning significant expansion or to eventually go public.
Stock options: S Corps can offer stock options, which can be a valuable tool to attract and retain employees.
Clear ownership structure: S Corps have a more defined ownership structure through shares, which can simplify transfers and valuations.
Now, let's review the steps for converting an LLC to an S Corp.
The conversion process can be complex and may have significant tax implications, depending on your state's laws and your specific circumstances. To formally make the transition, consult with a qualified attorney and tax professional to guide you through the ins and outs of this process.
Steps for converting an LLC to an S Corp
Check eligibility: Does your business meet S Corporation requirements (e.g., 100 or fewer shareholders, all U.S. citizens or residents)?
Get LLC member approval: Obtain approval from the LLC members to convert to an S Corporation. This usually requires a majority vote, but check your Operating Agreement for the specific requirements.
File articles of incorporation: File the essential business formation documents for compliance with your state to create a corporation. This step effectively creates a new legal entity.
Obtain an EIN: If your EIN was tied to your LLC, you'll need to apply for a new one for your corporation.
File Form 8832: File this form with the IRS to elect to be taxed as a corporation. This step is necessary because the IRS views LLCs as partnerships by default.
File Form 2553: Submit this form to the IRS to elect S Corporation status. This must be done 'no more than 2 months and 15 days after the beginning of the tax year the election is to take effect, or at any time during the tax year preceding the tax year it is to take effect, ' according to the IRS' instruction for Form 2553.
Transfer the LLC's assets: Formally transfer all assets and liabilities from the LLC to the new S Corporation.
Issue stock: Issue stock to the shareholders based on their ownership percentages in the former LLC.
Update contracts and accounts: Notify all relevant parties (banks, vendors, customers) of the change in business structure. Update contracts accordingly.
Establish corporate bylaws: Create and adopt corporate bylaws that outline the governance structure of your new S Corporation.
Hold a kickoff board meeting: Conduct a board of directors meeting to establish corporate formalities.
Maintain corporate formalities: Begin following S Corporation requirements, such as holding regular board meetings, maintaining detailed records, and following stricter accounting practices.
Remember, while converting to an S Corp can offer benefits, it also comes with increased administrative responsibilities and formalities. Carefully consider whether these align with your business goals and capabilities before proceeding with the conversion.
What options besides LLC and S Corp are there?
In addition to LLCs and S Corporations, there are several other business entity options available to entrepreneurs.
Here's a high-level overview of some common alternatives, including C Corporations and Sole Proprietorships:
C Corporations
C Corporations are traditional corporations that are taxed separately from their owners. They offer limited liability protection to its shareholders and have no restrictions on ownership. There is no limit on the number or type of shareholders.
A clear disadvantage to C Corporations is that profits are taxed at the corporate level and then they are taxed again when distributed to its shareholders as dividends.
An advantage, though, is the ability to raise capital through stock sales, which may appeal to investors and even potential employees who can get stock options.
If a C corporation is the right fit, and it usually is if you plan to raise from venture investors, Rho will incorporate your Delaware C-corp for free.* You get your formation documents, EIN, and a business bank account in one flow. Here’s what Rho’s incorporation covers.
*$400 fee, credited back once you deposit $10,000 of new money into your Rho checking account and keep your daily average balance $10,000 above where it started for the 60 days after you incorporate.
Sole Proprietorships
A Sole Proprietorship is a very simple business structure, and there's no legal distinction between the owner and the business. Note that it doesn't offer legal protection for the owner.
Forming a Sole Proprietorship is fairly simple and cost-effective. What's more, the owner has direct control of it.
As far as taxes, it is taxed as a pass-through entity: the business' income is reported on the owner's personal tax return.
General Partnerships
A General Partnership is a business structure where two or more individuals or entities jointly own and operate a business. All partners in a General Partnership share the management, profits, and losses of the business equally, unless otherwise specified in a partnership agreement.
So, each partner in a General Partnership is personally responsible for the debts and requirements. This means that personal assets can be at risk if the business has debts or faces legal issues.
A General Partnership is taxed as a pass-through entity.
While General Partnerships offer simplicity and flexibility to structure their business operations and profit-sharing, they also come with significant risks due to the shared liability.
What businesses choose to be General Partnerships?
General Partnerships are a common business structure used by various types of businesses, particularly small businesses involving two or more individuals working together.
Limited Partnerships (LPs)
LPs are a specialized form of partnership that combines elements of general partnerships and limited liability entities. LPs have two types of partners: general partners and limited partners.
LPs are typically taxed as pass-through entities.
Now, what are the roles and responsibilities of each of these partners?
Well, general partners are responsible for managing the business and making decisions. Limited partners are investors who contribute capital but don't participate in management.
In terms of liability protection, general partners have unlimited liability for the partnership's debts and obligations. Limited partners' liability, on the other hand, is restricted to their investment in the partnership.
LPs are often used in real estate investments, venture capital and private equity funds, family businesses, and professional services (in some jurisdictions).
Limited Liability Partnerships (LLPs)
In LLPs, all partners have limited personal liability for the debts and responsibilities of the partnership. In other words, partners are generally not personally responsible for the negligence, wrongdoing, or misconduct of other partners.
This type of business structure is common for professional service firms (e.g., law firms, accounting firms, consulting firms, engineering companies, architecture firms, and medical practices). It's particularly suitable for licensed professionals who want to work together while maintaining individual autonomy.
Note that not all states allow LLPs, and some restrict them only to certain professions. Also, in some jurisdictions, LLPs may face higher tax rates or fees compared to other business structures.
Professional Corporations (PCs)
PCs, also known as Professional Service Corporations in some jurisdictions, are a specialized type of corporation designed for licensed professionals. PCs are typically available for doctors and other healthcare providers, lawyers, lawyers, accountants, architects, engineers, and psychologists.
PCs offer personal asset protection for shareholders against the corporation's debts and obligations. But, PCs do not protect against personal malpractice or negligence.
In terms of taxation, PCs can be taxed as a C Corporation or elect S Corporation status for pass-through taxation, which may offer more flexibility in terms of tax planning compared to other structures.
Takeaway: What's the best choice, an LLC or an S Corp?
Each of these business structures has its own advantages and disadvantages, specifically in terms of liability protection, taxation, management structure, and operational flexibility. The choice of entity depends on various factors, including the nature of the business, number of owners, liability concerns, and tax considerations.
Remember, the rules and the availability of these entity types can vary by state. And, some industries may have restrictions on the types of entities they can form. So, make sure you consult with legal and tax professionals who can guide you on the most appropriate business structure for your specific situation.
For startups, the choice between an LLC and an S Corporation often depends on specific circumstances and long-term goals. LLCs offer more flexibility and simplicity, which can be beneficial for early-stage startups with limited resources. LLCs allow for easy management and decision-making processes, which can be crucial in the fast-paced startup environment.
On the other hand, S Corporations may be more attractive to startups planning to seek significant outside investment or considering going public in the future. The corporate structure and ability to issue stock can make it easier to draw investors and potentially transition to a C Corporation later on.
It's worth noting that good corporate governance practices may benefit both LLCs and S Corporations, particularly as they grow by potentially supporting sustainability and competitiveness.
Wrap up
Ultimately, the decision on whether a startup should be formed as an LLC or an S Corp should be based on the startup's specific needs, growth plans, and the preferences of its founders. Getting legal and financial counsel from professionals is a wise move to make the best choice for your particular startup's situation.