LLC (Limited Liability Company) is the legal agreement you make with the state you operate in. The LLC separates your personal liability and your finances from your business, but when it comes to taxes, it doesn’t give you an advantage.
S-election (form 2553), is a request you file with the federal authorities (IRS) to be taxed as a corporation. One of the key advantages of S-Corp is that it may pass income (along with other credits, deductions, and losses) directly to shareholders, without having to pay federal corporate taxes. Usually associated with small businesses (100 or fewer shareholders), S corp status effectively gives a business the regular benefits of incorporation while enjoying the tax-exempt privileges of a partnership. To become an S-Corp, the business must incorporate first.
Additional Information
An LLC (limited liability company) is basically what it sounds like; it’s a company set up by an individual or group to limit their personal liabilities in the business so they can operate it as a separate entity from their personal finances. The advantage of this type of filing entity exists mostly on the legal side: it creates an EIN (employer identification number) with the federal government that signifies your company can be treated as a separate being than your personal tax filings.
However, the limits of the LLC structure are that in a tax-paying sense it really doesn’t create much in the way of benefits. An LLC is a “pass-through” entity, meaning the income from the business passes through the LLC and lands on your personal return in the form of a Schedule C (or via a Schedule K if you’re in a partnership LLC). There’s almost no difference in this regard for you the taxpayer than if you never made an LLC, to begin with. The LLC won’t really do much to blunt the tax impacts for you from the business.
An S-corporation is a filing designation from the IRS that allows an LLC to “elect” to be treated as a corporation. It leaves in place the same flexibility and easy management of the LLC but also allows/requires the business to treat itself as a more corporate type of entity.
The great thing about S-Corps is you can retain independence and flexibility that you would enjoy as a simple LLC while enjoy huge tax savings and leveraging compensation and benefits that normally would be unavailable as a sole proprietor with an LLC. Things such as 401k account matching and health insurance premiums are normally deductible in a large company but wouldn’t be offered to smaller LLCs with no payroll or corporate status.