LLC vs. Corporation

If you’re considering starting a business, one of the crucial decisions you’ll need to make is choosing a legal structure or an entity type. Your choice of a business entity has a lasting impact on how efficiently you run and grow your company, its profitability and tax obligations. LLCs and corporations are the most popular options, but how do you know which is right for you? 

Benzinga spotlights LLCs and corporations, providing a constructive overview of their differences, including tax implications, liability protection and management structure. So whether you’re a budding entrepreneur or a small-business owner looking to take your company to the next level, read on to know which options will best fit your business needs.  

What is an LLC?

A limited liability company (LLC) is a legal business structure that grants owners personal liability protection. The implication is that your liability in the company’s debt or obligations doesn’t exceed your equity or the amount of money you invested. Your home, automobile and other personal assets cannot be used as collateral to pay off the business debts after a lawsuit or bankruptcy. While personal liability protection is the most compelling benefit of an LLC, most small-business owners consider it appealing, primarily because of its flexible tax options. 

Although its default pass-through taxation means owners are not subject to double taxation, they can elect to be taxed as a corporation if they consider that more beneficial to the business. In addition, an LLC offers the most simple and flexible organizational and management structure. Owners are called members and often serve as the manager except when someone is appointed to manage the business or a registered agent is approved to act as one. One person can form an LLC. There’s no restriction on the number of members.

The operating agreement is the governing document of an LLC. Although not mandatory, it clarifies how the business operates, the economic burden and profit or loss allocation among members. Starting an LLC is also hassle-free. The most significant step involves filing an Article of Organization with your preferred state. This is known as incorporating a business. At that point, your assets and that of your member-owners will become separate from the company. 

What is a Corporation?

A corporation is a legal business structure or entity owned by shareholders and managed by a board of directors. Although like an LLC, a corporation grants shareholders personal liability protection, it is a more standardized business structure, unlike corporations. The implication is that it lacks the flexibility inherent in an LLC, especially regarding organization and management structure. For example, corporations must create bylaws governing their operation. They have a defined board of directors responsible for corporate decision-making. 

As a legal entity distinct from its owners or shareholders, a corporation has almost similar rights and responsibilities as the owners. For instance, a corporation can hire employees, enter contracts with other firms, loan or borrow money, pay taxes, own assets, sue and get sued. General corporations, or C corps, are subject to double taxation unless they elect to be taxed as S corps. In this case, the tax is pass-through.

Unlike an LLC, a corporation can issue shares and launch initial public offerings (IPOs), making it easier to attract investors, raise capital and transfer ownership when needed. A C corp can offer common and preferred stocks to woo diverse investors, while an S corp can offer one or the other. A corporation can be privately owned or publicly listed on major stock exchanges. The latter is regulated and subject to the rules of the U.S. Securities and Exchange Commission. Forming a corporation requires more detailed steps and may take longer than an LLC. One of the vital steps involves filing the Article of Incorporation by shareholders. On approval, they receive a Certificate of Incorporation.

Comparing LLC vs. Corporation

LLCs and corporations differ significantly. Here are the core differences.

Taxes

One of the fundamental differences between an LLC and a corporation is taxation. Here's how tax works for each of the entities. 

LLC Taxes

An LLC tax is pass-through by default, just like a sole proprietorship and general partnership. Specifically, single-member LLCs are taxed as sole proprietorships, while multimember LLCs are taxed as general partnerships. In a pass-through system, profits or losses from the business are reported on the owners' personal tax returns and not at the business level, thereby eliminating double taxation and simplifying tax filing for business owners. 

Nevertheless, an LLC can elect to be taxed as a general corporation (C corp) or an S corp if it makes sense for the company. Members are also subject to self-employment tax, and depending on the state, franchise taxes may apply. The franchise tax is an annual tax imposed by some states on LLCs, corporations and partnerships for the privilege of doing business or incorporating their company in the state. Failure to meet the tax obligations may result in penalties or involuntary business dissolution. 

Corporation Taxes

Corporations, by default, are subject to double taxation. The first is on profits from income at the corporate level because they're considered independent legal entities. The corporate tax rate was 21% in 2022. The second tax is on the personal income level when shareholders receive dividends. While double taxation may seem like a disadvantage, businesses can offset it by leveraging various federal tax deductions unique to corporations. 

Another excellent option is reinvesting the profits if paying dividends is not the company's long-term goal. Reinvested profits are not double-taxed. Remember that a 15% accumulated earning tax may apply for earnings held beyond reasonable needs. Nevertheless, a corporation can elect to be taxed as an S corp if it has fewer than 100 shareholders and meets other core requirements outlined by the IRS. This allows a corporation to be treated as a pass-through entity for tax purposes, just like an LLC, while enjoying other benefits of a traditional corporation. 

S Corporation Taxes

Like LLCs, S corps are treated as pass-through entities for tax purposes, so there's no double taxation. The only difference between LLCs and S corps regarding taxation is that, unlike dividends in S corps, distributions of profit in LLCs are subject to self-employment taxes. With excellent planning and guidance from a certified public accountant (CPA), an LLC can avoid paying self-employment tax by electing to become an S corp. 

Business Ownership

Owners of a corporation are referred to as shareholders. A shareholder can be an individual, a company, an organization or a  trust with at least one share of the corporation's stock. The more shares a shareholder has, the higher their ownership stake in the business. Both private and public companies issue shares of their stocks to woo investors. Shareholders can also buy more shares to increase their ownership percentage of the corporation or sell it to reduce ownership stakes. The business will continue to exist when an owner divests from or exits the business. 

In contrast, an LLC is owned by members. Ownership is not strictly determined by financial contributions among members but by rules stipulated in the operating agreement. And unlike a corporation, members of an LLC can be foreigners or foreign entities. The operating agreement also outlines how ownership can be transferred between members when such needs arise and the company's future when a member leaves. An LLC may dissolve if a member exits, except continuity is clearly defined in the operating agreement. 

Management

The members of an LLC can oversee and control the daily operation of the business (member-managed) or elect an investor to supervise day-to-day activities (manager-managed). There's often no distinction between owners and managers when LLCs are member-managed. This flexible management structure makes LLCs highly appealing to entrepreneurs. In contrast, corporations have a formal management structure. 

The board of directors manages and grows the business, while corporate officers oversee daily operations. Although the shareholders can vote to elect or be elected as directors or appointed as an officer, they're separated from business decisions and day-to-day operations. Once formed, corporations are guided by bylaws adopted by the board of directors. In contrast, an LLC may or may not be guided by the operating agreements. 

Formal Requirements

Both LLCs and corporations must maintain specific formal requirements in their states of incorporation to maintain their limited liability protection. The specific requirements vary from state to state but are more rigid for corporations. Corporations are required to hold annual shareholder meetings, the details of which are documented as corporate minutes. 

Corporations also must file annual reports to keep the secretary of state’s office updated with the company's information. Operational changes can only occur via corporate resolution voted on in a meeting with the board of directors. In contrast, LLCs require no annual meetings, and little or no record-keepings is needed. But most states mandate filing annual reports.

Legal Discrepancies

Corporations as a business structure are as old as the United States. The implication is that the legal framework guiding their operations, especially regarding the legal protection of owners or shareholders, has become standardized over time. Therefore, corporate laws and their interpretations are essentially uniform in all U.S. states. In contrast, LLCs as an entity came into existence in the late 1970s, with Wyoming being the first state to draft LLC statutes in 1977. 

Being relatively new and a hybrid entity blending the simplicity of sole proprietorship and the liability protection of corporations, the laws guiding it are not yet fully developed and may differ across different states. While the laws will become uniform over time, the current lack of uniformity may influence your choice between an LLC and a corporation.

Establish Credibility and Professionalism by Incorporating your Business

LLCs and corporations offer unique benefits and are worth considering when choosing an entity type for your business. Choices might be individualized, but it often comes down to taxation and how you want to manage or structure your business. 

Do you prefer a more flexible management structure? Are you looking to raise capital or woo investors by issuing shares or IPOs? Do you have the requisite resources to handle complex business operations, or do you prefer simplified business formation and operations? If you can concisely answer these questions, then it's time to incorporate your business and give it the credibility and professionalism needed to stay competitive.

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