Choosing the right entity type for your business is one of the most important decisions you’ll make when starting a company. This choice will impact how your company is run, how the profits are shared, how you pay taxes, and so much more.
Many business owners and investors find themselves deciding between two options—LLC or corporation.
But which one is right for you and your business?
This guide will take a closer look at the similarities and key differences between LLCs and corporations. We’ll also highlight the pros and cons to help you compare your options and make an informed decision.
What is an LLC?
A limited liability company—or LLC—is a legal business entity formed at the state level. This business structure provides personal liability protection to owners (hence the name) while simultaneously offering the pass-through taxation benefits of a sole proprietorship.
In terms of ownership, management structure, and taxation, LLCs are extremely flexible. One or more people can own an LLC, and the owners are known as “members.”
When an LLC is formed, the acronym (or an accepted alternative) is included in your official business name (e.g., Joe’s Flower Shop LLC, Joe’s Flower Shop Ltd, Joe’s Flower Shop Limited Liability Co., etc.).
Types of LLCs
Not every LLC is the same. There are several different types of LLCs that you can form, based on factors like ownership, location, profession, and more.
- Single-Member LLC — As the name implies, these LLCs have one single owner. For tax purposes, the IRS treats SLLCs the same as a sole proprietorship. Owners don’t need to file separate taxes, and tax on profits appears on the owner’s personal return (known as pass-through taxation).
- Multi-Member LLC — These LLCs are controlled by multiple owners (members). The equity for each member and the management structure can vary. Each member won’t necessarily operate as equal partners. This is spelled out in your LLC filings.
- Member-Managed LLC — Business operations and decision-making is controlled by the owner(s)/member(s). This LLC structure type is ideal for business owners who want to be hands-on and involved with the day-to-day business.
- Manager-Managed LLC — Managers (who may or may not be owners) control the business operations. Owners can choose to operate as a “silent partner” in a manager-managed LLC. Management roles are defined in the LLC’s operating agreement.
- Domestic LLC — The term “domestic” refers to where a company is registered and operates within the US. A business with a physical presence in the same state in which the LLC is registered is known as a domestic LLC.
- Foreign LLC — Foreign LLCs are formed in a state where a business is not operating and does not have a physical presence. For example, if your business is in California, but you register in Delaware, you’ll have a foreign LLC in California. There are several “tax-friendly” states where entrepreneurs are drawn to register an LLC. But foreign LLCs are still required to file in their home states as well.
- PLLC — A professional limited liability company (PLLC) is required for certain licensed business professionals. Examples include doctors, lawyers, accountants, and more. Some states have ownership restrictions for PLLCs, and all members must hold a license for whatever professional services are being rendered.
LLCs can fall into several category types listed above. For example, you can have a multi-member, manager-managed, domestic LLC.
What is a Corporation?
A corporation is another type of legal business entity that is separate from its owners. Corporations typically have multiple owners (although some states do allow one owner).
Some of the world’s most well-known companies are corporations (e.g., Microsoft Corporation, the Coca-Cola Company, etc.).
Ownership in a corporation is represented by holding stock. These businesses can either be for-profit or not-for-profit. Corporations can become publicly traded, where the general public can buy shares of the company on the open market.
While most global giants are corporations, it’s worth noting that many small businesses decide to incorporate as well.
In terms of day-to-day operations, corporations are formed so that a single person does not typically have controlling power over decisions. Voting shareholders elect a board of directors responsible for appointing management, electing officers, executing the business plan, and overseeing day-to-day operations.
Types of Corporations
Three main types of corporations exist in the US. Here’s a general overview of each one:
- C Corporations — C corps are taxed separately from the owners under federal income tax laws. There is no limit to the number of shareholders in a C corporation. Shareholders of a C corp can also be employees, and C corps are required to have a board of directors. This category is better for larger companies that may eventually want to go public.
- S Corporations — The taxation for S corps is similar to partnerships in the sense that income is taxed at the shareholder level as opposed to the corporate level. In addition to income, any losses, deductions, or credits are passed to shareholders as well. To qualify for the S election, the corporation is only allowed to have one stock class and cannot exceed 100 shareholders.
- Nonprofit Organization — Nonprofits are required to use revenue to achieve specific goals (usually something for a greater cause). Surplus revenues cannot be distributed as profits or dividends. However, profits can be used for self-preservation or expansion of the nonprofit.
It’s also worth noting that LLCs can elect to be taxed as corporations. Although this doesn’t make them a corporation, they are still legally considered an LLC.
Pros and Cons of LLCs and Corporations
Each type of business entity has its fair share of pros and cons. You’ll also notice some similarities between LLCs and corporations.
- Pass-through taxation (no need for separate return)
- Personal liability protection for owners
- Less paperwork
- Lower filing costs
- Simpler operating structure
- No limit to the number of owners
- Members can receive revenues higher than ownership percentage (unrestricted pay)
- Easier to start than a corporation
- Members can have full control over the operation and final decisions
- Easy to maintain
- Ability to change tax structure
- Members are subject to self-employment taxes
- Automatic dissolution can be triggered in certain circumstances (e.g., death of a member without provisions in the operating agreement)
- Can be difficult to raise capital from outside investors
- Excise taxes
- Can’t issue stock
- Can’t use corporate income splitting to reduce tax liability
- Liability protection to shareholders
- Easier to attract investors
- Easier to lower tax burden
- Easier to transfer ownership
- Can exist forever
- Stock options can help attract top-level talent (employees)
- Ability to sell stock
- Well-established business structure
- Possibility of double taxation
- Limited number of shareholders (for S corps)
- Strict regulations and less flexibility
- More expensive and time-consuming to start
- Large amount of paperwork
LLC vs. Corporation: Key Differences Compared
Now that we’ve had a chance to see the pros and cons of each entity type, it’s time to take a closer look at the two side by side. You should be evaluating certain factors when you’re deciding between an LLC or a corporation for your business. We’ll discuss those factors and the differences in greater detail below.
Unlike sole proprietorships, both LLCs and corporations alike must be legally registered in the state where they operate. All 50 states recognize LLCs, corporations, and variations of each one.
To file an LLC, the owner(s) (members) must file articles of organization with the state. They’ll also create an operating agreement, which is essentially a contract describing ownership percentages and how day-to-day operations are managed.
The process is a bit more in-depth for corporations. In addition to the articles of incorporation, you must also form a board of directors to oversee the business and its operations. The board must agree on corporate bylaws (comparable to the operating agreement for an LLC).
Exact costs vary from state to state, but it’s generally cheaper to form an LLC compared to a corporation.
The structure of ownership between LLCs and corporations is very different.
LLCs have a bit more freedom here. Ownership can be distributed to members regardless of the individual’s financial contribution. LLCs can have one owner or multiple owners, and there are no limits to the number of owners.
Corporations typically don’t have single owners (some states do allow it). Ownership is distributed based on stock shares. Owners can buy and sell shares to own more or less of the company. Corporations can issue shares to outside investors as well. Each shareholder of a corporation is technically considered to be an owner.
C corps can have an unlimited number of shareholders, and there are no restrictions on which type of shares can be issued (common stock vs. preferred stock). S corporations are limited to 100 shareholders and one type of stock.
LLCs have a flexible management structure. They can be managed by owners (member-managed LLC) or by someone else (manager-managed LLC). All of this is outlined in the LLC operating agreement.
Corporations are much more strict. They are required to have a board of directors (voted on by shareholders), which is responsible for overseeing daily operations by electing corporate officers (CEO, COO, CFO, etc.).
It’s worth noting that shareholders can be elected to the board of directors and can also be appointed as an officer. These rules are dictated in the corporate bylaws of each individual corporation.
In short, corporations are typically structured so that no single individual doesn’t have the final say in business-related decisions.
LLCs have the most flexibility in terms of how they are taxed. By default, an LLC will be subject to pass-through taxation. LLC owners are required to pay self-employment taxes. However, LLCs have the option to be taxed as C corps or S corps, assuming they meet the requirements for each one and file the proper paperwork.
Similar to LLCs, S corps do not pay taxes at the corporate level. Shareholders pay taxes on their individual returns. Compared to other business entities, C corps have more options in terms of eligible deductions and expenses. However, C corps are subject to double taxation. This occurs when the company pays distributions to shareholders. Taxes were already paid on those profits, but shareholders must also pay taxes on their personal returns (based on their individual rate).
Nonprofit corporations are eligible for tax exemption status with the IRS.
Formal Requirements and Compliance
LLCs and corporations both need to fulfill certain formal requirements set by the state in which the entity was formed. Examples include annual report filings, maintaining a registered agent, and paying franchise taxes. These keep the business in good standing with the Secretary of State and help maintain the liability protections associated with each entity type.
The requirements for corporations are much more stringent compared to LLCs. They are required to hold annual shareholder meetings, and details of the meeting must be formally documented in notes known as “meeting minutes.” If a corporation wants to take certain actions or make changes, they must be formally decided with a corporation resolution during a meeting with the board of directors.
LLCs definitely have fewer formal requirements than corporations. They don’t need to have a board of directors, hold annual meetings, or keep a record of meeting minutes. Some states do require annual reports for LLCs, but that’s not too difficult to keep up with.
Both LLCs and corporations are considered legal entities. This means that they are recognized separately from the individual owner(s).
For lawsuits and business debts, an owner’s liabilities are limited to their investment and stake in the company itself. Their personal assets are protected.
With that said, there are some instances in which a judge could rule that an LLC owner is not personally protected. If the owner violates rules (such as mixing personal and business expenses), creditors and suitors can potentially go after the individual’s personal assets.
Corporate owners have greater protection. For example, if you own shares of a corporation and it gets sued, your personal assets are not at risk.
LLC or Corporation: Which is Right For Your Business?
So, what’s better—an LLC or corporation?
There’s no definitive answer to this question.
Generally speaking, an LLC is a better option for owners who want to maintain control over how the company is run. It’s an excellent choice for people who don’t want as many formal requirements, and LLCs are also cheaper and easier to start than corporations. Another unique benefit of an LLC is the ability to be taxed as a corporation.
Corporations are ideal for businesses that want a bit more regulation in terms of the company’s management structure. It’s also easier for corporations to raise outside capital from investors by issuing shares. It can be appealing for prospective employees to work at a corporation where stock options are offered. If your end goal is to get acquired or sell shares of your company, a corporation will be a better option for you.
As always, consult with your accountant and attorney before deciding to incorporate or form an LLC.