Does an S Corporation Provide Better Limited Liability Protection Than an LLC?

Many people seem to think that an S corporation offers better legal protection than something like limited liability company. But this assumption is wrong--and for at least two reasons.

S Corporations not "real" corporations

The first reason that this idea is wrong is that an S corporation is not real corporation. An S corporation is a fiction of federal tax law. Really, when you boil everything down to its essence, an S corporation is just a set of tax accounting rules. And many entities can use the S corporation tax accounting rules: corporations, limited liability companies, and a whole bunch of other entities as well.

The bottom line, therefore, is that an S corporation absolutely does not offer extra legal liability protection. The S corporation accounting methods provide big benefits... but not extra legal protection.

LLCs probably better option

Let me also, though, talk about the second reason this trash-talking of the LLC option is wrong. As a practical matter, a limited liability company almost surely offers small business owners and investors better legal protection than a regular, traditional corporation.

LLCs arguably offer better limited liability protection because of a couple of really significant factors. First, an LLC requires far less formal governance. An LLC, for example, doesn't require annual shareholders meetings, a board of directors, and regular board of directors' meetings. No way. Limited liability companies were designed by state legislatures to be "light" versions of the traditional corporation. By design, the limited liability feature of LLCs is supposed to be harder for small businesses and investors to screw up. All the LLC and its members really need to do is have and follow an operating agreement.

Some states' LLCs better than other states

A second factor may also give LLC owners in many states better legal protection. But let me explain. In some states, owning an interest (shares) in a limited liability company is actually safer than owning stock in a small business corporation. In many states, creditors can gain ownership of your shares in a small business corporation (and therefore can control the corporation). But in many states creditors cannot gain ownership of your interest in an LLC. In these states, a court can tell the LLC to redirect distributions that would normally go to the LLC member to some creditor of the LLC member. But this ability--called a "charging order"--still gives the LLC and its member tremendous protection and negotiating leverage.

Note: While I recommend most small business owners use an LLC as the platform for an S corporation for the reasons just given, the individual pages selling do-it-yourself S corporation kits provide two versions of the kit. One version builds an S corporation on top of a limited liability company. The other version of the kit builds an S corporation on top of traditional or regular corporation.

Back to list of frequently asked questions


Additional Information You May Find Useful

If you want additional information about how to maximize the tax savings related to running a business or investment venture, you may also be interested in one of our downloadable e-books (see descriptions below). Each book covers a category of tax planning topics that easily save a business owner significant amounts of income or self-employment taxes (potentially thousands of dollars a year) and is instantly downloadable.

Maximizing Section 199A Deductions

Often the best tax saving tool private companies have? The Section 199A deduction which allows them to avoid taxes on the last 20 percent of their income.

Read More
S Corporations Salary Secrets cover image

Using an S corporation for your business? To maximize savings, you need to minimize the salary paid to shareholders. But this decision is tricky.

Read More
Maximizing Employee Retention Credits image

Nearly secret, the federal government's employee retention credits provide tremendous payroll tax savings for most small businesses... A new book from our firm explains.

Info here