LLC versus Corporation: Key Differences, Tax Impacts, Ownership Structures, and Management Considerations

Choosing between an LLC and a corporation affects ownership, taxes, management responsibilities, and liability protections for your business structure. Compare differences in formal requirements, legal treatment, and funding opportunities to select the best option.

By Douglas Wade, Attorney

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Table of Contents

1. Introduction

2. What is Limited Liability?

3. Does my LLC need to become a corporation?

4. Are LLCs considered corporations?

5. Should you form a corporation or an LLC?

6. Corp vs LLC: Tax Differences

7. Corp vs LLC: Business Ownership

8. When is a C Corp the best option?

9. When is an S Corp the best option?

10. When is an LLC the best option?

11. Corp vs LLC: Management

12. Corp vs LLC: Formal requirements

13. Corp vs LLC: Legal Discrepancies

14. Corp vs LLC: Pros & Cons

15. Corp vs LLC: Which one to choose

16. Summary

Introduction

Selecting a type of entity is one of the initial choices you will make when launching a new company. The majority of business owners typically decide to create a corporation or LLC (Limited Liability Company). One of the most crucial steps in the business registration process is choosing between an LLC and a corporation. An LLC has ownership by one or more people, but a corporation is held by its stockholders. This is the primary distinction between the two types of business structures.

Both corporations provide significant advantages to your company, regardless of which one you select. By incorporating your company, you can demonstrate your professionalism and credibility. Limited liability protection is another benefit it offers.

What is Limited Liability?

One kind of safeguard for your own assets is limited liability. It guarantees that your personal responsibility for the debts and liabilities of the company will not exceed the capital you contributed to the company. This keeps any obligations incurred by your company from being paid off with your home, cars, and additional personal assets.

If you don’t have limited liability coverage, your house can be taken as security for the company’s debt in the event of a lawsuit and bankruptcy. Among the most significant benefits of establishing a business corporation is this one.

Does my LLC need to become a corporation?

An LLC can have benefits from becoming a corporation, particularly if you want to draw in investors or grow your company considerably. The form of corporations facilitates the process of raising funds through the sale of stock, which is advantageous for companies that intend to expand rapidly or add new shareholders. Additionally, some businesses and investors prefer the more formal framework that corporations provide, with duties that are well-defined. Before implementing the transformation, it’s crucial to assess whether the additional legal obligations and possible double taxation that come with becoming a corporation complement the company’s objectives.

Are LLCs considered corporations?

A corporation is not the same as an LLC. An LLC is actually a special kind of hybrid business that combines the liability safeguards of forming a corporation with the ease of working as a sole proprietorship.

Should you form a corporation or an LLC?

There is no denying the advantages of incorporating the business, which includes liability protection and tax savings. You must take into account the primary distinctions between the two entities—such as ownership, management, taxation, and yearly maintenance requirements—in order to select the one that best suits your company.

Corp vs LLC: Tax Differences

The tax treatment of corporations & LLCs is one of their main distinctions. Let’s look at the taxation of each business structure.

LLC Taxes

By default, an LLC is subject to taxes as a pass-through company. This indicates that the owners, also known as members, receive a portion of the company’s income. Owners’ personal tax returns, not the company’s, are where profits & losses are recorded. As a result, LLC owners frequently find it easier to file taxes. Individual tax returns allow the deduction of business losses and operating expenses, which can be used to offset other sources of income.

As with filing as a single proprietor, the tax rate for an LLC is determined by the owner’s overall earnings. Additionally, self-employment taxes may be due from LLC owners. LLCs must pay franchise taxes in some states. This tax is imposed by the state in exchange for the right to conduct business there. Franchise taxes vary by state and are typically paid once a year.

What transpires if taxes are not paid? Penalties & even the forcible liquidation of your business may follow late or nonexistent payments.

Entrepreneurs are fortunate to have flexibility when they choose to incorporate as an LLC. The taxation of an LLC might be either a corporation or a C corporation. Incorporating an LLC under a C Corp tax categorization is a rare decision, but for some firms, it makes financial sense.

Corporation Taxes

Corporations pay taxes as distinct legal entities with the ability to generate their own revenue. It is the duty of corporations to pay taxes on their earnings (corporate tax) and on dividends paid to shareholders. Dividends are subject to double taxation since they are not tax deductible, unlike salaries & bonuses. This phenomenon is known as double taxation. Smaller businesses where just the proprietors work for the company do not have this problem. Owners instead earn bonuses and salaries that are tax deductible.

Businesses that decide to file as corporations may find double taxation to be a drawback, although this extra tax obligation is frequently compensated through federal deductions which are exclusive to corporations.

A company, for instance, is able to deduct all of its business expenses. These may involve operations and marketing expenses, as well as any fringe benefits offered to employees, like retirement and health insurance. Over time, the corporation might save a significant amount of money because of all of these deductions.

The flat tax rate of 21% that corporations pay on the profits they make as of 2018 is less than the highest five personal tax rates. Even while double taxation mainly offsets this, the corporation will only pay taxes once at the updated 21% rate on any income it chooses to keep at the conclusion of the year. This enables the corporation’s owners to reinvest a portion of their profits again in the company, thus reducing their tax obligations.

Remember that a company may elect to become an S Corporation if it has less than 100 shareholders. A company with this tax status can be regarded as a pass-through organization, similar to an LLC. This could be a suitable choice for companies that wish to have some of the extra formalities that a corporation offers but yet want to be treated like an LLC. While taxation via flow-through (no corporate tax) is permitted under the S Corporation title, there are specific requirements to meet that may restrict the S Corporation’s applicability to a given business.

S Corporation Taxes

The tax distinction between an S Corporation and an LLC is a little more complex if a company meets the requirements to become one. An S Corp and an LLC both have flow-through taxes, which eliminates double taxation. Note that dividends paid by an S Corp are not subject to employment tax, while earnings distributed by an LLC are.

See our S Corp. Tax Calculator for additional details on how filing as an S Corporation could result in annual tax savings.

A small business that chooses to register as an S Corp can avoid paying high employment taxes with meticulous preparation. However, a small corporation may be discouraged from utilizing this benefit due to the disadvantages of an S Corp. Always seek professional advice before choosing to be treated as an S Corporation or an LLC.

Corp vs LLC: Business Ownership

When choosing between forming a corporation and an LLC, ownership is still another crucial factor to take into account. Selecting the best entity for your company is made a little simpler by the fact that each business has a distinct function and a very diverse ownership structure.

When is a C Corp the best option?

A C Corp is the best option for companies wishing to raise a lot of money or go public because it makes it easier to find investors and permits an infinite number of owners.

A company can sell its owners, known as shareholders, a portion of the company and distribute units of stock. These shareholders may sell off stock to own a smaller portion of the company or buy additional stock to own a higher percentage. A corporation can be the ideal business structure if you wish to draw in outside investors. Additionally, a corporation lasts forever separate from its owners, which means that it continues to exist even if one owner departs or sells their stake.

When is an S Corp the best option?

Small to medium-sized enterprises that wish to prevent paying two taxes while still making use of some of the benefits of a corporation can choose an S Corporation. Although S Corps provides some liability protection, profits and losses are distributed to shareholders, resulting in only individual tax payments. For entrepreneurs who wish to streamline taxes while preserving the legal advantages of a company form, this arrangement is perfect.

When is an LLC the best option?

For companies looking for more managerial flexibility and less formalities than a corporation, an LLC is a fantastic choice. Because income is passed down to members and recorded on individual tax returns, it is also advantageous for owners who wish to reduce their own liability while maintaining simplicity in their taxation. LLCs are ideal for sole owners, startups, and small enterprises that want simple taxation and autonomy in operation without the hassles of corporate governance.

An LLC is allowed to divide its ownership stake among its members regardless of how much money each member has contributed to the LLC. Consider the scenario in which one LLC member might not have made as large an investment as another. An LLC may include in its operating contract that each member will get an equal portion of the earnings regardless. When it comes to determining who owns the company, this gives more options.

Additionally, foreign persons, other organizations, or any type of trust may own an LLC. Businesses may find this to be the best option in specific situations where these considerations are crucial.

The operating contract of an LLC also specifies the terms of the transfer of membership interests between the members, if any, and the termination of a member. If not specified in the operating contract, the LLC must be disbanded by default when a member departs.

Corp vs LLC: Management

The structure of an LLC’s management is adaptable. Any member can serve as the company’s manager, and the organization may be run by the members themselves or by a team of managers. It is also possible for the LLC to decide not to distinguish between a management and an owner. For some business owners, LLCs may be the best option because of their flexibility and less formal management.

What makes “manager-managed” LLCs different from “member-managed” LLCs? Whereas a manager-managed LLC typically has investors who sit on the fence and don’t play any other active part in the firm, a member-managed LLC has owners who monitor its daily operations.

The management structure of a corporation is considerably more rigid. A corporation must be formally organized, with an elected board of Directors in charge of managing the company’s operations and making money for the shareholders. The daily management of the company is the responsibility of the corporate officers. Although they are regarded as the company’s owners, the stockholders are not involved in day-to-day operations or business choices (with the exception of approving significant corporate decisions).

Nonetheless, shareholders continue to have the authority to choose directors, and any shareholder may be chosen to serve as an officer or a director. The corporate regulations, a comprehensive set of regulations approved by the Company’s Board of Directors upon the formation of the corporation, govern each particular rule of the organization.

Corp vs LLC: Formal requirements

Both corporations and limited liability companies must comply with the state’s reporting and/or maintenance obligations. This preserves the company’s reputation and the limited liability shield that came with its formation. Although each state possesses its own laws governing corporations and limited liability companies, corporations are typically subject to more annual obligations than LLCs.

Every year, corporations must have a meeting of shareholders. These specifics, as well as any conversations, are recorded in what are known as company minutes. It is typically mandatory for corporations to provide an annual report. This keeps the Secretary of State informed about the company’s current status. Every action or modification to the company will need a corporate motion that is put to a vote at a board of directors meeting.

In contrast, LLCs are subject to less stringent record-keeping regulations than corporations. For instance, an LLC does not need a board of directors, annual meetings, or minutes. LLCs must still submit yearly reports to certain states, although not all of them do. For information on the requirements that apply to your LLC entity, contact the appropriate Secretary of State.

Corp vs LLC: Legal Discrepancies

While corporations and limited liability companies (LLCs) offer their owners legal protections, there are distinctions between these two types and how the legal system views them.

Companies have existed from the beginning of American history. The statutes have grown standard as a result of the corporation’s development and maturity as an organization. To assist in resolving conflicts and problems pertaining to businesses, US courts have decades of legal precedent. For corporations, this results in a great deal of legal stability.

Companies with limited liability are still seen as being somewhat “new.” The 1970s saw the initial recognition of their entity as the hybrid of the corporate & partnership/sole proprietorship forms. Because of its twofold nature, an LLC adopts the traits of both legal bodies. States regard LLCs differently, nevertheless, because they are a “new” legal structure that combines aspects of a partnership and corporation.

Although the LLC regulations of the majority of states are similar, there are certain variations that could cause a company to decide to establish a corporation in one state but an LLC in another. There will eventually be greater uniformity in LLC laws across the US. These differences in LLC legislation shouldn’t matter to most businesses, but for some, they might be the decisive factor.

Corp vs LLC: Pros & Cons

The distinct advantages and disadvantages of each should be taken into account while choosing between forming a corporation and an LLC. The decision between a corporation and an LLC might affect operational freedom, legal duties, and taxes, therefore it’s critical to thoroughly consider the advantages and disadvantages.

Pros

In contrast to corporations, LLCs provide less formality and more managerial freedom. Conversely, corporations offer more robust access to financing and can be more appropriate for companies that intend to become public or look for outside funding.

Cons

Since LLCs normally aren’t allowed to issue shares, their choices for obtaining money may be limited. In contrast, corporations must deal with more complicated tax laws and stringent regulations, which can raise their operational expenses and liabilities.

Corp vs LLC: Which one to choose

A few things to think about when choosing between an LLC and a corporation are your business objectives, your tax choices, and the degree of protection from liability you require. Small firms are best suited for LLCs because they provide greater flexibility and more straightforward tax arrangements. Companies that want to raise money, go public, or draw in investors, however, are better off as corporations. Both your long-term business plan and the amount of complexity in operations you can handle should guide your choice.

Summary

Both limited liability firms and corporations, each with unique advantages, keep owners separate from the company and offer limited liability safeguards for their personal belongings.

How do you decide which type of entity to set up a company as—an LLC or an Inc.? In the end, choosing the entity that best fits your objectives is a crucial first step in starting a business.

It is also advised that you consult with a certified public accountant or lawyer. They may offer further information about the procedure and assist in addressing any queries you may have on the best entity for your company.

Have a quick question? We answered nearly 2000 FAQs.

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