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  • Lindsay Spiller

What distinguishes an "S Corporation" from an "LLC taxed as an S Corporation?"

Updated: Dec 18, 2022

The distinction between an LLC and an S corporation.

When business owners ponder what entity to choose for their small businesses, the choice is often between an LLC or an S corporation, thinking that they are deciding between two legal entities. Indeed, an LLC is considered a legal entity. However, an S corporation is a tax classification, or is perhaps better understood as as an election undertaken by a legal entity (it need not be a corporation) that has decided to be taxed under subchapter S of Chapter 1 of the Internal Revenue Code.

To create an S corporation, you must first form the underlying legal entity (a business entity formed in compliance with state statutes), such as a traditional corporation or an LLC, then you must elect S corporation tax status by timely filing Form 2553 with the Internal Revenue Service. So when we refer to an "S corporation," we are generally referring to a corporation that has elected subchapter S status.

Default Tax Classifications and other possible Classifications

A corporation or an LLC may choose among several tax classifications:

As shown in the table above, a traditional corporation is by default classified as a C corporation. However, it may elect to be treated as an S corporation. The default tax classification for an LLC depends on whether the LLC is a single-member LLC or a multi-member LLC. For single-member LLCs, the default tax classification is that of a sole proprietorship (considered by the IRS to be a “disregarded entity"). For multi-member LLCs, the default tax classification is that of a partnership. However, as in the case of the corporation, the LLC may also elect to be classified under subchapter S.

Does electing S status alter the the nature of the underlying entity?

As long as the corporation or the LLC honors the particular requirements necessary to maintain the S status under IRS code sec 1131 (described in more detail below), the S classification will not impact the typical operations or governance of either entity. If the entity is a corporation, it would still have a board of directors. officers, and bylaws, and it would still need to comply with the required corporate formalities such annual meetings, minutes, and corporate consents. If the entity is an LLC, it would still operate as and exhibit the characteristics of an LLC ---- its membership, management structure and operating agreement would be that typical of an LLC.

Requirements to maintain S corporation status

While electing S corporation tax status need not fundamentally alter the operations or governing structure of the underlying entity involved, the entity may nevertheless have to alter its operations and governing documents enough to at least abide by the restrictions necessary to maintain subchapter S standing under IRS code §1131, which requires, among other things, that the entity

  1. Have no more than 100 shareholders

  2. Require its Shareholders to be U.S. citizens or legal residents