S Corporation Versus LLC: What is the Difference?

Updated: Sep 11

What is an S corporation and what are its advantages over an LLC for a business in Washington State?

First, what is an LLC and why is it useful?

Limited liability companies were developed in the eighties, to provide a relatively easy way for small businesses to form a legal entity, as well as combining the benefits of a partnership and a corporation.

Partnerships have an advantage because they are only taxed once; there is no partnership tax. Income and loss from the partnership are reported on the partner's personal tax return, and are assessed based on that partner's personal tax bracket. However, that means that partnership liabilities–tax or otherwise–flow directly to the partner, meaning a creditor could reach personal assets.

Corporations solve the liability problem by shielding an owner's personal assets from the debts and liabilities of the company. If the corporation injures someone, for instance, that person is generally limited to suing the corporate entity, and not the owners personally. However, this means that the corporation pays its own income tax, so profits are taxed twice: first at the corporate level, and then the owner's personal income. Corporations may ameliorate this tax issue by incorporating in states with the most favorable corporate tax laws, such as Delaware and South Dakota.

LLC's are taxed once, like a partnership, but also enjoy the liability shield of a corporation. This shield can be pierced, however, in cases where the owner is not treating the LLC like a separate entity. This happens when an owner doesn't keep assets separate, undercapitalizes the business, and otherwise treats as if it's no different than the owner. This is why an LLC is such a popular business entity to form, and also because it's easy to form and doesn't require the formalities required in the structure of a corporation.

What is an S corporation?

First, an S corporation is a tax classification, not a business entity. Thus you can reclassify your LLC as an S corporation under the tax code. With an LLC, profits pass through the owners' personal tax returns, and the owners pay income and self employment tax on the entirety of the profits. With an S corporation, the owners pay the same taxes on their returns, but only on a predetermined salary, and profit distributions are only subject to income tax. An LLC in WA should be classified as an S corporation only if there is enough profit carried over every year to pay all the owners a reasonable salary and significant distributions.

If you have more questions about the advantages of an LLC and S corporation under Washington State law, please contact In-house | On-site to speak with a Vancouver, WA attorney.

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