An LLC, short for limited liability company, is a type of business entity in the US that offers liability protection to its members. Thanks to the LLC structure, members cannot be found personally liable for any of the debts or liabilities of the company.
LLCs are a relatively easy business entity to form and offer its owners flexibility in management style and minimal administrative pains, among other benefits. One or more members can form an LLC by filing articles of organization with the appropriate state agency.
A corporation is a type of business entity formed by shareholders in pursuit of a common goal or purpose and is a popular choice for businesses all over the world. Corporations can have one or multiple owners (shareholders) and are considered separate entities, offering ownership limited liability protection. So, while shareholders can enjoy profits from the corporation, they cannot be found personally liable for any of its debts.
Additionally, corporations hold many of the same rights and responsibilities that individuals do, such as entering contracts, paying taxes, borrowing money, hiring employees, and more. Note that a corporation is regulated by the jurisdiction in which it is legally formed.
Also important to know is that there are multiple types of corporations, such as a C-corp, S-corp, and non-profit.
Now that you have an understanding of these two entity types, we’ll run through some of the key differences between them. Weigh the advantages and disadvantages offered by both corporations and LLCs to get a sense for which entity type would be best suited to match your business goals. This is an important foundational decision for your business, so it’s worthwhile to invest some time into making the right choice early on.
When it comes to corporations and LLCs, how these entities are taxed is one of the most important distinctions to understand. As noted earlier, a corporation is considered a separate legal entity and is taxed as such. For this reason, corporations face what is known as “double taxation.” Because corporations must pay taxes on their income, any profits distributed to shareholders will end up being taxed twice, as the shareholders must also report the dividends on their personal tax return.
Note, however, that S-corporations differ from C-corporations in this regard. S-corporations enjoy what is known as a “pass-through” tax classification, which means that the corporation’s profits avoid taxation on the corporate level and pass through to be taxed at the individual level. Keep in mind that there are specific requirements a corporation must meet in order to elect an S-corporation designation:
LLCs, on the other hand, have the default classification of pass-through entities (though also have the option of electing to be taxed as a corporation). As noted, this pass-through classification means that the profits of the LLC are reported on the personal tax returns of the LLC ownership. This can greatly simplify your tax filings when compared to that of the often times complicated corporate tax filing process.
If you’re looking to attract outside investors to your business, there are some important distinctions between corporations and LLCs. For starters, if attracting venture capital funds is important to your goals, know that most investors favor a C-corporation entity structure. Additionally, if you have (or are planning to have) foreign owners, the C-corporation structure is once again favored. Also, note that S-corporations do not allow foreign investors.
When it comes to funding for LLCs, this entity type is typically more attractive to businesses looking for a smaller number of investors, rather than those seeking multiple rounds of financing and issuing varying classes of equity. But if these elements are not important to your business, an LLC can be a great choice that offers asset protection and flexible ownership structuring.
Both corporations and LLCs have reporting requirements that must be completed in order to maintain good standing in their state. These reporting requirements differ in some regards between the two entity types and will also vary depending on which state your business was formed, as each has their own regulations.
Corporations are required to hold an annual shareholder meeting in which corporate minutes are taken. Any proposed changes must receive a majority vote by the shareholders in order to move forward. Also, corporations are required to file annual reports with the state.
On the other hand, LLCs have fewer reporting requirements, as they do not have the same formal structuring that corporations have, such as a board of directors, corporate minutes, and annual shareholder meetings. Additionally, certain states don’t require LLCs to file annual reports.
Be sure to consider the ownership structure when choosing between a corporation and an LLC. Corporations have the ability to issue shares of stock, which represent a percentage of ownership in the company. This ownership (stock) can be purchased, sold, or transferred, adjusting the shareholder’s level of ownership as a result. Additionally, corporations do not rely on any one owner but rather exist in perpetuity regardless of whether an owner departs or divests.
LLCs enjoy the ability to distribute ownership stake in the company as they see fit and do not need to correspond to the financial contribution of the member. This ownership structure must be outlined in the LLC’s operating agreement and include how membership will be transferred among members or what happens when a member leaves.
Another important difference between corporations and LLCs are their management structures. Corporations have a relatively stricter management structure when compared to that of LLCs. A Board of Directors is elected to handle management responsibilities with the aim of generating profits for shareholders and corporate officers are chosen to manage the company’s day-to-day operations. While shareholders aren’t directly involved in management decisions or day-to-day operations, they hold the ability to elect directors or serve as a director or officer themselves.
LLCs enjoy much more flexibility in their management structure and have the option to be member-managed or manager-managed. A member-managed LLC is where the LLC owners oversee the day-to-day operations of the business. Whereas a manager-managed LLC is when members do not have an active role in the business but rather hire a manager to oversee the daily operations.
After going through some of these key differences between corporations and LLCs, hopefully you have a better sense of which entity type will best suit your needs and goals. While there aren’t particularly cut and dried guidelines for which entity type is best for each business or industry, you can use the comparison above to determine which factors are most important to your business and what you hope to achieve.