What Is the Difference Between an LLC and an S Corporation?

Many clients ask us whether they should create a new business as a Subchapter S Corporation or as a Limited Liability Company. How you organize a new business has both tax consequences and asset protection consequences. For income tax purposes, the LLC and the S Corp are mostly similar. But, the LLC offers clear asset protection advantages.

Income Tax Difference: Florida LLC vs Florida S Corporation

When we ask clients to describe their privately owned businesses, we realize that many are confused about their description of their business as either a Florida LLC or a Florida S corporation. The confusion lies in failing to understand the difference between the business as a legal entity and the tax status of the business entity.

Corporations and LLCs are Defined in Florida Statutes.

A Florida corporation is a corporation established through the Florida Department of State pursuant to Chapter 607 of the Florida Statutes. A Florida limited liability company is an LLC established through the Florida Department of State pursuant to Chapter 605 of the Florida Statutes.

There is no entity under Florida law called an “S Corporation” or a “Subchapter S Corporation.” The primary Florida business entities are corporations, liability companies, and partnerships.

Subchapter S is an Income Tax Choice

Subchapter S is a part of the U.S. tax code that, among other things, provides for the pass-through of a business’s income and loss to the business owner. Subchapter S entities do not pay any tax at the entity level because all taxation is reported on the individual owner’s federal tax return. The tax code has rules about which business owners, and how many owners, may elect to have their business taxed under Subchapter S.

Corporations that elect Subchapter S taxation are referred to as
“Subchapter S Corporations” or “S Corps.” Corporations that do not elect S Corp treatment are mostly taxed under Subchapter C as “C Corps.” C Corps are subject to being taxed at the entity level, and their dividends are taxable to individual owners. There are other types of corporate tax elections, but S Corps and C Corps are the main tax options for corporations.

LLCs Can Elect Their Tax Status

One of the advantages of LLCs in Florida is tax flexibility.

One reason why most new small businesses are formed as LLCs instead of corporations is that LLCs may choose how they want to be treated by the IRS for tax purposes. A newly formed LLC by filing IRS Form 8832 can elect their federal tax characteristic. An LLC may elect to be taxed as a corporation. An LLC that elects corporation tax status may then file the Form 2553 to be taxed under Subchapter S.

An LLC that files 8832 and a 2553 form is treated for tax purposes the same as a corporation that elected S corporation status. The entity is still legally an LLC, and not a corporation, but the LLC is treated for tax purposes as a Subchapter S corporation.

A multi-member LLC that does not file a Form 8832 is taxed as a partnership. A single member LLC is disregarded by the IRS for tax purposes so that LLC income and loss is reported on the owner’s Schedule C of his Form 1040 annual income tax return.

So, someone who describes their business as an “S Corp” should clarify for the listener whether their business is legally a corporation or whether their business is legally an LLC that elected through Forms 8832 and 2553 to be taxed as an S Corp.

Asset Protection Differences: Florida LLC vs Florida S Corporation

There are differences between your ability to protect your membership interest in a Florida LLC and your shares of a Florida S corporation. The differences translate to greater creditor protection from an LLC if your LLC has more than one member.

S Corporation Asset Protection

Shares that you own individually in a corporation offer no asset protection. This is true for S corps and C corps.  A creditor holding a judgment against you can levy on your stock in your business corporation. If the business has not issued stock certificates, or you lost stock certificates, the court can order the business to issue you new ones.

The local sheriff can seize stock certificates, and your creditor will likely acquire your stock at auction. Once the creditor takes your stock, the creditor will own and control your business. The creditor holding stock in your business may take the money in your business bank account and dispose of other business assets.

LLC Asset Protection

Your personal creditors have limited ability to collect a judgment from your LLC membership interests. Florida law provides that a judgment creditor cannot seize or garnish your LLC membership interests in a multi-member LLC. Your  judgment creditor cannot attack LLC  financial accounts, real estate, or other LLC assets

Florida law restricts your judgment creditor’s rights to a charging lien, or charging order, against your multi-member LLC interest. Florida Statute 605.0503 provides that the charging order is the creditor’s exclusive remedy against your membership interest.

The charging order gives the creditor a lien against any distributions, if any,  of cash or other property that the LLC pays you.  If the LLC does not distribute money, your judgment creditor receives nothing. All undistributed assets and accrued cash flow remain inside the LLC.

Even though a charging lien “traps” money inside your multi-member LLC, the result is better than a creditor levying upon stock in your business corporation. Because it prevents a creditor from satisfying its judgment from your LLC profits, the multi-member LLC gives you negotiating power to reach a favorable settlement of an outstanding money judgment.

Single-Member LLCs

Single-member LLCs provide less asset protection than multi-member LLCs. Florida law permits creditors to use foreclosure and other alternative collection remedies against your interest in a single-member LLC if the creditor demonstrates to a court that its judgment will not be satisfied in a “reasonable time” from a charging lien.

If your interest is sold through foreclosure, the creditor will acquire your membership interest and replace you as the LLC’s sole member. Therefore, LLCs designed for asset protection should include at least two members.