LLC vs. Corporation

While the LLC vs. Corporation debate will illustrate many similar benefits, there are also several key differences to consider when choosing the right structure for your specific business activity.

If you are trying to decide between an LLC and a Corporation, you might find it a bit daunting since the two business entity types have similarities. Below, we’ve shared some of the key areas to think about as you compare a Corporation vs. an LLC. Consider consulting an attorney and accountant or tax advisor to discuss each business structure’s pros and cons as you decide which might be the right fit for your situation.

1. Registration with the State

Both LLCs and Corporations are formed by filing forms with the state. The paperwork required, filing costs, and formalities vary from state to state.

  • LLC Registration – In most states, the official document to form an LLC is called “Articles of Organization.” Some states call it by other names, such as “Certificate of Organization” or “Certificate of Formation.” Owners of an LLC are called “members.” An LLC may be formed by a solitary member (single-member LLC) or multiple members (multi-member LLC). Some states also require that an LLC file an Initial Report. There may be other requirements, as well, depending on the industry, type of business, and location.
  • Corporation Registration – When entrepreneurs want to incorporate a business (form a C Corporation), they must file “Articles of Incorporation” (sometimes called “Certificate of Incorporation”) with the Secretary of State (or comparable agency) office to register a Corporation.
    Owners of a Corporation are called “shareholders.” While most Corporations are formed by more than one individual or entity, states will allow incorporation of a business owned by a sole individual or entity. When forming a Corporation, the business’s stakeholders must elect a board of directors. Members of the board represent shareholders’ interests. They meet at regular intervals to review and approve the company’s financial statements, review management policies, make strategic decisions, and oversee other aspects of the business.

2. Entity Management Documents

Both entity types must follow the provisions within their internal management documents that spell out essential aspects of operating the business.

  • LLC Operating Agreement – Generally, LLCs do not have to file an LLC operating agreement with the state. However, they may be required to keep one at the LLC’s principal place of business. An operating agreement documents the rights and obligations of an LLC’s members and the distribution of income.
    For an LLC operating agreement to be valid and legally binding, all of the LLC’s members must sign it.
  • Corporate Bylaws – Corporations must create and maintain bylaws that lay out the rules governing how their affairs will be conducted. While bylaws typically do not get filed with any state offices, they stand as a record of how a Corporation will operate in compliance with the state’s statutes.

3. Limited Personal Liability

Both structures limit their owners’ liability by the amount the members or shareholders have invested in the company. Therefore, owners’ personal assets—such as homes, cars, savings, investments—are protected from the business’s liabilities and risks. This is an important consideration when starting a business—the sole proprietorship and general partnership structures provide no personal liability protection because they are considered the same legal entities as their owners.

4. Income Tax Structure

Both the LLC and Corporation offer some tax treatment flexibility. Whether the default tax structure or an alternative method is ideal will depend on various factors, so it’s helpful to talk with an accountant or tax advisor to assess your situation.

LLC Income Tax:

  • Default Tax Structure – While an LLC is considered a separate entity from its owners for legal purposes, it is, by default, treated as a “disregarded entity for tax purposes. This means an LLC’s income tax obligations pass-through to its owners, avoiding an entity-level (corporate) income tax. Business income or losses are reported on the individual tax returns of the LLC’s owners. Business profits reported on those individual tax returns are subject to self-employment taxes (Social Security and Medicare taxes). Because members of an LLC are not on the payroll of the company (members get paid through owners draws) and therefore do not have tax withheld from paychecks, LLC members must make quarterly estimated tax payments throughout the year.
  • Potential Tax Benefits of the LLC Structure – Here’s a brief summary of the tax benefits entrepreneurs may get by forming an LLC:
    • A simplified tax filing process
    • No double taxation (see information about a Corporation’s default tax treatment below)
    • Tax flexibility (may elect to be taxed as an S Corporation or C Corporation)
  • S Corporation Tax Election – LLC owners may elect to be taxed as a Corporation by submitting a special filing with the IRS. The LLC can be taxed according to the default corporate method or elect to be treated as an S Corporation (also known as a “Subchapter S Corporation”). As an S Corporation, members working in the business must be put on payroll and receive a reasonable wage for their work. Only wages and salaries paid to LLC members through payroll are subject to self-employment taxes. The remaining profits paid as distributions to LLC members don’t get hit with Social Security and Medicare taxes. For some business owners, having their LLC taxed as an S Corp may help reduce their personal tax obligations.

Corporation Income Tax:

  • Default Tax Structure – A C Corporation is a tax-paying entity, separate from its owners. It gets taxed on its profits at the corporate income tax rate. Many people use the term “double taxation” when referring to a Corporation’s income tax treatment. That’s because the Corporation pays taxes on its profits. Then the individual shareholders pay taxes on the dividend income they receive from the business. Profits paid out to shareholders as dividends may not be included as a deductible expense for the Corporation. Therefore, those profits get taxed twice—once at the corporate level and then again at the individual shareholder level.
  • Potential Tax Benefits of a Corporation – Here’s a list of some of the tax benefits entrepreneurs may get by incorporating:
    • More eligible business tax deductions (such as employee benefits and net operating loss) than other types of business structures
    • Avoid paying self-employment taxes on all company profits
    • Ability to leave some profits in the business to fund growth and expansion
    • Ability to spread out net operating business losses over time (i.e., defer them forward)
    • Tax flexibility (may elect to be taxed as an S Corporation)
  • S Corporation Tax Election – Corporate shareholders have some options to help avoid double taxation. One of them is to elect to be treated as an S Corporation. S Corp tax treatment means that the Corporation’s profits and losses flow directly to its shareholders’ individual income tax returns. With pass-through taxation to the business owners, the company does not pay income tax at the corporate level. As with LLCs that elect to be treated as S Corps, only shareholders’ wages and salaries—not profit distributions— are subject to self-employment taxes.

5. Number of Owners

Both Corporations and LLCs can be formed by one or multiple owners. An LLC may have an unlimited number of members. Likewise, a C Corporation may have an unlimited number of shareholders.

However, Corporations and LLCs that elect to be S Corporations may only have up to 100 members or shareholders.

6. Ability to Raise Capital

Both the LLC and corporate structures allow a business to borrow money and sell equity to raise capital. Some other key points about funding them include:

  • LLC Capital Options – LLCs are not permitted to issue stock in any state. However, they may bring on new members (if the operating agreement allows it) to contribute financially to the business. Generally, venture capitalists and sometimes angel investors may not be interested in (or they might be prohibited from) financing a business formed as a pass-through entity.
  • Corporation Capital Options – Corporations may sell shares of company stock to raise capital. This offers expanded opportunities for growth, especially for C Corporations, because they can have an unlimited number of shareholders and issue multiple classes of stock. If a Corporation files as an S Corp, it may issue only one class of stock and cannot have more than 100 shareholders.

7. Duration of Existence

The LLC and corporate entity types continue indefinitely (perpetual existence), even if members or shareholders leave the business or pass away. Therefore, to officially close an LLC or Corporation, the business owners must file Articles of Dissolution with the state.
However, if owners intend to operate the business for a limited duration, they may state a dissolution date or term of existence in their formation documents (or LLC operating agreement or corporate bylaws).

8. Profit Distribution

  • LLC Profit Distribution – By default, an LLC’s profits and losses will be divided among the members according to their percentage of ownership interests. However, if approved by the IRS, the LLC may allocate profits and losses of the business to its members as agreed upon by all of the members. This allows the business owners to consider not only monetary contributions but also expertise and participation in running the LLC in determining profit distribution.
  • Corporation Profit Distribution – A Corporation’s profits may be reinvested in the business (with limits), or a portion may be paid as dividends to shareholders. Dividends can only be paid pro-rata (proportionately) to share ownership. Losses of a Corporation are not reported or claimed by the company’s shareholders.

9. Management

  • LLC Management – An LLC may have its members or managers handle the company’s day-to-day management responsibilities. Unless the company’s formation documents or operating agreement state otherwise, the LLC will usually be considered a member-managed.
  • Corporation Management – Corporations must have a board of directors to establish policies and oversee the business to ensure it is in compliance with regulations and follows its bylaws. Officers of the Corporation (appointed by the board of directors) manage the day-to-day management responsibilities.

10. Reporting, Recordkeeping, Ongoing Compliance

The laws of the state—which vary from state to state— govern LLCs and Corporations. Generally, LLCs have less government oversight and fewer formalities than Corporations. Failure to stay on top of compliance tasks may result in fines, penalties, loss of liability protection, and even involuntary dissolution (forced closing) of the business entity.

A few of the requirements both business structures must fulfill include:

  • Maintain a registered agent at all times
  • Report and pay applicable taxes and fees
  • Keep owners’ personal finances separate from those of the business

Other possible compliance requirements include the following:

  • LLC Reporting
    • Filing an annual report with the state
    • Renewing business licenses and permits
    • Holding annual meetings and recording minutes (and getting approval by members)
  • Corporation Reporting
    • Filing an annual report with the state
    • Renewing business licenses and permits
    • Holding board of directors meetings and recording minutes (also getting approval —usually from board members)
    • Holding an annual shareholder meeting and recording minutes (and approving them as determined by the company’s bylaws)

Additional Resources

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