This is a question that we are frequently asked, so here is a brief comparison between the two. They both have certain similarities. They are pass-through tax entities and offer some degree of liability protection. However, an LLC would be more likely to offer superior liability protection over an S corporation based on the individual state laws where the entity is incorporated. The pass-through taxation feature means that the income or loss is reflected on the personal income tax returns of the owners.
However, there are many other areas where the two are quite different. The ownership of an S corporation is restricted to 75 shareholders. An LLC has no restriction on the number of shareholders. S corporations are restricted to U.S. citizens as shareholders whereas LLCs have no such restrictions. An S corporation cannot be owned by C corporations, other S corporations, partnership, LLCs and many kinds of trusts. LLCs have no such restrictions.
S corporations are restrictive when it comes to distributing profits. An S corporation can only have one class of stock and your percentage ownership in the stock determines your percentage of pass-through income or loss. An LLC does not have these restrictions. It can have multiple classes of interest and the pass-through profits or loss are not dependent on the ownership percentage. The members can set an agreement that allows for the pass-through percentage to differ from the ownership percentage.
S corporation stock is freely transferable to others, while an LLC ownership is not. The operating agreement generally requires approval from the other members before ownership can be transferred. This is generally regarded as a plus from an asset protection point of view, so that a creditor cannot get an ownership in the company.
S corporations also can have an advantage with the payment of self-employment taxes. It is generally assumed that most income from an LLC is subject to self-employment taxes, whereas the dividends from an S corporation are not.