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What are the main differences between an LLC and a corporation?
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LLC vs Corporation Overview
Starting a business is a wonderful and exciting journey.
As an entrepreneur, one of the first business decisions you’ll need to make is to decide on which business entity you’ll form to operate your business so you can make your dream become a reality.
Choosing between a limited liability company (LLC) and a corporation becomes important in this context.
If you’re looking to know what are the main differences between an LLC and a corporation, you are at the right place.
In this post, I will explain to you what’s a limited liability company and then a corporation.
Keep reading to the end of this post as that’s where I have compiled a list of advantages and disadvantages for you to consider for each business entity type.
Now, without further adieu, let’s start by defining what’s an LLC.
What Is A Limited Liability Company
A limited liability company, or LLC, is a type of corporation that you can form in the United States that has several key characteristics.
An LLC is similar to a corporation in many ways although there are some differences.
One of the most important features of an LLC is that it offers personal asset protection (or limited liability protection).
Since the LLC is a separate vehicle entity from its owners (or members), you are personally shielded from business debt and liability.
The owner of the LLC is called the member whereas in a corporation it’s called a shareholder.
Also, LLCs are typically formed by filing what’s called the articles of organization whereas corporations are formed by filing the articles of incorporation.
In essence, a limited liability company is a legal entity that many entrepreneurs choose in the United States to operate their small business as it offers key features of a corporation while offering more flexibility in certain areas like how the business income is taxed.
Later in this article, I’ll go over the key features of an LLC so you can better understand what I mean.
What Is A Corporation
A corporate is a type of business entity that is formed by filing the articles of incorporation or similar paperwork with the state where you intend to form the company.
Corporations are one of the most recognized types of business entities as most public companies in the United States are formed as corporations.
The reason why many entrepreneurs form a corporation is to benefit from personal asset protection.
The objective is to ensure that your business creditors cannot hold you personally liable for business debt and obligations.
In addition, corporations are one of the most preferred business entities if you’re looking to eventually bring investors into your company or go public.
Having a flexible ownership structure, corporations are great business structures to have to be able to raise financing.
With corporations, you will have a clear separation of your business and your personal affairs.
I invite you to read on as I’ll give you more details on why corporations are great business entities.
Difference Between LLC and Corporation
You’re here to know what are the main differences between LLCs and corporations.
Let’s get to it!
From an ownership perspective, there are some differences between limited liability companies and corporations.
A corporation is owned by its “shareholders”.
Every shareholder in the company owns a percentage of the total shares issued and outstanding by the corporate entity.
The shares of a corporation can be held by individuals, corporations, or LLCs.
The company can easily issue shares to new shareholders and can authorize additional shares to be issued.
Most venture capitalists and investors prefer corporations as they’re able to easily acquire shares in the company and eventually sell their shares for a profit.
Limited liability companies are owned by “members” where each member has a “membership interest” in the LLC.
Anyone can become a member of the LLC, such as domestic or foreign individuals, corporations, or even other LLCs.
In many cases, LLC members will put in place an LLC operating agreement where they will outline every member’s membership interest and determine how the company is to be operated.
When an LLC does not have an operating agreement in place outlining its operating rules, then the business entity will be managed by state laws.
From a management perspective, corporations are governed by their board of directors.
The board of directors is composed of individuals who are appointed to oversee the business operations, appoint and manage the company officers, and ensure that the company is on the right track.
Each member of the board of directors is elected by the shareholders of the corporation.
In essence, the corporation’s shareholders (the owners) are different than those who manage the company (board members, CEO, VPs, and managers).
Note that when a new company is formed by a single person, the same individual will wear different hats and will be simultaneously a board member, the company CEO, VP, and employee.
However, as the corporation grows, these roles will become more and more separate.
On the other hand, limited liability companies can be managed either by their members or by managers.
An LLC can have a hierarchical structure as a corporation where you have a CEO, VPs, and managers or the members can create another type of structure that suits their business needs.
When an LLC is “member-managed”, it means that the LLC owners are the ones who assume the day-to-day operations of the company.
When an LLC is “manager-managed”, it means that the LLC owners have delegated the operations of the LLC to external parties where the members will act in a supporting role.
Whether you form a corporation or an LLC, you’ll need to make sure that you respect your ongoing obligations so you maintain your business entity in good standing with the state where it was formed.
Corporations are typically required to hold an annual meeting of the shareholders who appoint the members of the board.
The annual shareholder meeting must be properly documented in the corporate minute book.
In addition to that, corporations are required to file an annual report (and pay the applicable fees) with the state where they were formed so they keep their information up-to-date.
LLCs may also have some ongoing requirements to observe but they tend to have less formalities than corporations.
One important difference is that a limited liability company does not have the obligation to hold annual meetings, elect a board, or keep minutes.
Every state establishes the specific ongoing compliance requirements for LLCs that you’ll need to become familiar with to see the exact requirements to keep your LLC in good standing.
There are important differences between a corporation vs LLC.
When a corporation is formed, by default it will be taxed as a C corporation.
This means that the company’s income will be taxed directly into the hands of the company.
The shareholders do not have to report the corporation’s business income on their personal income tax.
However, when the corporation pays the shareholders dividends, the shareholders are personally taxed on the dividend payment.
This concept is called “double taxation” where the same dollar earned is taxed in the hands of the corporation and then taxed again in the hands of shareholders.
If you want to avoid double taxation, following the formation of your corporation, you can elect to be taxed as an S Corporation.
S corporations allow business income to flow directly to the shareholders eliminating the double taxation of income.
However, you must meet specific requirements to qualify as an S Corporation (such as not having more than 100 shareholders as an example).
LLCs, on the other hand, are taxed differently.
If you have a single-member LLC, you’re taxed like a sole proprietorship.
If you have a multi-member LLC, you’re taxed like a partnership.
This means that the LLC business income is not taxed in the hands of the LLC and then in the hands of the members, the business income flows directly to the members.
An LLC can choose to be taxed like a C Corporation, or an S Corporation to the extent it qualifies.
As you can see, the LLC offers a more flexible structure for taxation where the members can choose to have the entity taxed like a corporation or a partnership.
From a legal liability perspective, corporations and LLCs offer their owners limited liability protection.
In other words, the shareholders in a corporation and members of an LLC are personally shielded from business debt, liability, or lawsuits (unless a personal guarantee was granted or in other situations like cases of negligence, etc).
To ensure that LLC members and corporate shareholders are personally protected, they must make sure that their business entity is in good standing at all times.
This means that they must make sure to respect the registration rules where their business entity was formed and pay the applicable fees.
Also, it’s important that the company transactions are kept separate and apart from the owner’s personal transactions to ensure that there’s no confusion.
LLCs and corporations are required to have a registered agent who is legally authorized to receive legal documents on behalf of the company.
Corporations have the additional obligation of making sure that they appointed a board of directors, hold annual shareholder meetings, and maintain a corporate minute book.
LLC vs Corporation Pros and Cons
Now that you have an overall view of the main differences between a limited liability company vs corporation, let’s look at some of the advantages and disadvantages for both entity types.
Here are some of the advantages of operating a business as a corporation:
- Typically, startups choose corporations to attract private equity firms, venture capital investments, or private investors
- C Corporations can choose to keep their retained earnings to avoid double taxation
- Corporations can offer benefits such as stock options and employee share purchase plans
- Corporations have control over how much money flows down to shareholders
- You can split income between business entities resulting in lower corporate tax rates
- You have limited liability protection
- The biggest and most reputable businesses in the world are operated as corporations
If you are operating your business as an S Corporation, here are some advantages to consider:
- S corporations can pass on business losses to shareholders
- You may potentially save on self-employment and Social Security taxes
Here are some of the benefits of limited liability companies:
- You benefit from pass-through taxation
- LLC owners can personally deduct business losses on their personal income tax
- LLC owners can manage the LLC themselves or give it to managers
- You have limited liability protection
- You can allocate business profits and losses to the members regardless of their membership interest proportion
- LLC owners can pay less taxes when the LLC borrows money
- Property contributions to LLCs are not taxable
- You can have foreign members
Here are some of the disadvantages of operating a business as a corporation:
- You have double taxation where the company pays taxes on its income and shareholders pay taxes when the company’s net profits are distributed to them in the form of dividends
- You must respect the management structure of corporations where shareholders elect the board who will then elect the company officers
- You must keep a minute book where you document the company’s important decisions, board meetings, shareholder meetings, and so on
If you are operating your corporation as an S Corporation, here are some disadvantages associated with that:
- You can only have one class of stock
- Business profits and losses can only be allocated based on capital contribution from shareholders
- You cannot have more than 100 shareholders
- You cannot have non-resident aliens owning shares of the S Corporation
- You don’t have tax savings on operating losses
- You must pay taxes on benefits if you own more than 2% of the shares
Here are some disadvantages of operating a business as an LLC:
- You cannot issue stocks to investors
- You’ll need to pay taxes on business profits even if the profits are kept in the LLC
- LLC members are generally required to pay self-employment taxes
- An LLC can potentially be dissolved if a member leaves the LLC
- Every state may treat LLCs differently from a legal perspective having less uniformity than corporations
LLC vs Corporation FAQs
Is an LLC a corporation?
An LLC is not a corporation.
In the United States, starting in the 1970s, the limited liability entity started being recognized as a valid business entity whereas corporations have been in existence for hundreds of years.
An LLC is sort of a hybrid between a corporation and a partnership.
Is it better to have an LLC or a corporation?
This depends on your specific objectives.
If you’re looking to grow your business, and attract venture capitalists and private investors, you may want to have a corporation.
If you’re looking to have the ability to choose how your business entity is going to be taxed, you may want to go for an LLC.
Which business entity offers better tax advantages?
This depends on your specific objective.
If you’re not looking to pull money out of your business entity and are ok to reinvest everything back into the business, a corporation may be the better option as you’ll only have the corporate taxes to pay.
On the other hand, if you’re looking to pass-through business profits and losses to the business owners and choose how much to be allocated to each business owner, you may want to go with an LLC.
So there you have it folks!
Many choose to form a corporation or an LLC to operate their business.
Fundamentally, both the corporation and LLC offer the business owners personal liability protection against business obligations which is why these two entities are so popular.
However, to decide which entity suits your needs, you’ll need to assess your objectives when forming your entity.
Both the corporation and limited liability company are solid business entity options for many but you may find that one is best for you.
I hope this article gave you an overall idea of the key features of a limited liability company vs corporation.
Don’t forget that you should consult a qualified attorney or professional to understand the specific tax and legal implications of forming an LLC or corporation.
I sincerely hope that you succeed in your business venture.
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