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Choosing the right business entity—more specifically, a limited liability company (LLC) vs. a corporation—is an important step in setting up your business, as it ensures you have the right structure to meet your business size and needs. Whichever you choose, either will offer plenty of advantages such as liability protection, a formal operating structure, and added credibility for your newfound company.
LLCs and corporations (sometimes referred to as incorporated) are distinct classifications that offer their own strengths and weaknesses. So which one is best suited for your needs? Let’s take a look at the basics to help you decide.
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Differences Between LLCs and Corporations
Both these business types will require you to file business formation documents with the state. Both protect company owners from personal liability for business obligations. In general, corporations have a more standardized and rigid operating structure and more reporting and recordkeeping requirements than LLCs. LLC owners have greater flexibility in how they run their business.
Taxwise, LLCs have more options than corporations. LLCs aren’t tied to one particular tax classification and can be taxed as sole proprietorships, partnerships, C corporations or S corporations.
Shares in a corporation are far easier to transfer than ownership interests in an LLC. This makes a corporation appealing for a business owner looking for outside investors.
Let’s take a closer look at the differences.
Ownership Structure
An LLC’s owners are called “members.” Each member owns a percentage, or “membership interest” in the business. Individuals, corporations, other LLCs, and foreign individuals can own membership interests in LLCs.
The ownership of an LLC is outlined in the business’ operating agreement—other details include the percentage each member owns, how the business is run, and how the company will deal with a new or departing member. Without an operating agreement, the LLC operates according to state law. In some states, the LLC needs to be dissolved if a member leaves, with the remaining owners forming a new LLC if they wish.
A corporation is different from an LLC in that corporate owners are known as “shareholders” whose ownership percentages reflect the number of shares of company stock they own. It’s relatively easy for a corporation to authorize additional shares, or for shareholders to transfer their shares to someone else.
Management
LLCs can be managed by their members (owners), or they can be managed by one or more managers, with the members acting more like passive investors. The people running an LLC–whether members or managers– don’t have to adhere to traditional roles or titles like CEO or Vice President, but can create a management structure that works for their business needs.
In contrast, corporations operate with a much stricter management structure, with a board of directors overseeing the business and officers who manage daily operations. Shareholders must meet at least annually. Paperwork and record-keeping for shareholder and director meetings is extremely important with corporations.
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Taxes
There are two ways a corporation can be taxed. By default, corporations are C corporations. They file a corporate tax return and pay corporate taxes. If the shareholders take distributions from the company, they’ll report those distributions on their personal tax returns (along with any company salary they receive) and pay personal income taxes on them.
Some corporations can avoid this double taxation of distributions by electing to be taxed as an S corp. S corps don’t pay corporate income tax. Instead, the company’s profits pass through to the shareholders’ personal returns and each shareholder pays individual taxes on their portion. To be eligible for S corp. taxation, a corporation must have 100 or fewer shareholders and meet additional ownership requirements.
LLCs, on the other hand, don’t have an IRS tax classification of their own. Single-member LLCs are automatically taxed like sole proprietorships and multi-member LLCs are automatically taxed like partnerships. In either case, company profits pass through to the members, and the members pay income and self-employment taxes on their share. But an LLC can also elect to be taxed as a C corp. or–if it qualifies–an S corp.
Taxation is a complicated topic that may or may not influence whether you choose an LLC vs a corporation. Always get advice from an experienced accountant about the best tax classification and strategy for your business.
Legal Liability
Both corporations and LLCs are limited liability entities. This means the owners aren’t personally liable for business debts or lawsuits against the business. Business owners do, however, remain liable for their own negligence and for any obligations on which they’ve signed a personal guarantee.
To maintain this liability protection, both corporations and LLCs should always keep business and personal finances separate. Owners should sign documents and contracts on behalf of the company, not in their own personal capacity. For corporations, additional documentation needs to be maintained as well. This includes corporate minutes, details on annual shareholder meetings, and information on its board of directors.
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LLCs and corporations also need to make required filings and reports to stay in good standing with the state. Both types of businesses must maintain a registered agent and update the agent information on file with the state as necessary. Most states require LLCs and corporations to file an annual report or franchise tax reports to maintain an active status. The annual report form will ask you to ensure you have updated information pertaining to your business and you will have to pay a filing fee. Some states require this to be completed every other year.
There may be additional paperwork required for certain types of corporations, such as public benefit corporations needing to undergo a verification process and file annual benefit reports.
Frequently Asked Questions (FAQs)
Which type of business owner is best suited for a corporation?
Business owners that want to scale their business by hiring employees and taking on outside investors are best suited for a corporation. Corporate shares are easier to transfer than LLC membership interests, and established investors tend to prefer the well-established and predictable structure of a corporation. Entrepreneurs who want to create a business that upholds their commitment to a positive impact on society or the environment may want to consider forming a benefit corporation, or B-corp, if it’s available in your state.
Is filing an LLC expensive?
The cost of your LLC will depend on a number of factors, like your state, the service you book with and any extras like an operating agreement. For a more detailed look at what you can expect to pay, check out our guide to LLC costs.
Which business entity will offer me the best tax advantages?
The answer depends on the kind of business you have, your income, your goals and your business’s ownership structure. There’s no one-size-fits-all answer, and it’s always best to talk to an experienced small business accountant before you make a final decision.
LLC vs. inc.: What are the differences?
LLC is short for limited liability company. Inc. is short for incorporated, which means the company is a corporation. The owners of a corporation are called “shareholders,” while the owners of an LLC are known as “members.” Corporations have a well-defined management, ownership and tax structure that make them well-suited to attracting outside investment. LLCs have a great deal of flexibility, making them a popular choice for small business owners.
What is the difference between an LLC and LLP?
Although they sound similar, there are differences between an LLC and a limited liability partnership (LLP). While both feature aspects of corporations and partnerships, there are differences in how the management of each entity is set up, there are different tax benefits and liability insurance obligations for each one as well as different liability protections that each one offers. While all of the partners can be liable in an LLC, only the managing partner of an LLP is liable for the actions of the partnership as long as any other partners remain in the background without assuming a leadership role. The remaining partners are protected in an LLP in that case.
