6 Main Differences between an LLC and a Corporation

Approximately 543,000 new businesses are started each month in the U.S. Starting a new business can be an exciting undertaking that comes with many benefits. However, before you venture into any business, there are vital decisions that you must make which will determine the success of your venture. 

One of the most critical decisions to make at the inception of your business is your preferred business entity type. Most entrepreneurs choose between forming a Corporation and a Limited Liability Company. In this post, we will examine the differences between these two entities.

1. Information and running the business

A corporation is formed by filing the necessary corporate organization documents referred to as articles of incorporation and bylaws. A corporation is incorporated in the state the business is located and has a rigid management structure.  It has a board of directors who are fiduciaries and steer the business towards a sustainable future and officers who implement the board’s directives and oversee day-to-day operations. The owners of a corporation are called shareholders.  By choosing to incorporate your business, you will be required to hold annual shareholder meetings and subject to specific recordkeeping requirements.

An LLC is formed by filing articles of organization in the state the business is located and executing an operating agreement.  The owners of an LLC are called members.  An LLC has a more flexible management structure that allows members to operate without formal business titles and gives the option for a group of members to manage the business. An LLC also has minimal record-keeping rules, and in most states, it is not required to file annual reports.

2. Size and ownership structure

The owners of corporations are known as "shareholders." A corporation issues shares to owners that correspond to their percentage of ownership. For example, if a corporation has 1,000 shares and you own 500 of them, you own half of the corporation. Corporations are also structured to adopt a perpetual life, allowing for shareholders, directors, and officers to come and go without threatening the existence of the corporation. It is also easy to transfer corporate shares to another person without any effect on the corporation's operations or structure.

LLC owners, on the other hand, are referred to as "members" as they own a membership interest or business percentage. There is a stringent restriction on transferring your LLC membership interest to another person. In some states, prior to a transfer, approval from other members is required. Likewise, if a member leaves, files for bankruptcy or dies, the LLC can be dissolved.

3. Profits and losses

Legally, corporations are considered separate entities from the owners, and, as such, the corporation reports all profits and losses. Corporations are required by law to pay income taxes on its profits or losses.  Conversely, in LLCs, all profits and losses flow through to the members, who report their share of the LLC's earnings on their individual tax returns. 

4. Taxation

Corporations are typically taxed as S corporations or C corporations.  Notably, C corporations pay corporate income tax on profits. In addition, shareholders are required to pay personal income tax on the profits paid as dividends. S corporations pay taxes on profits paid out as dividends only and, thus, avoid double taxation.

LLCs, on the other hand, do not have any tax classification form and have the leeway to choose how they are taxed. An LLC can elect to be taxed as an S corporation, a C corporation, a partnership, or a sole proprietorship.

5. self-employment taxes

Corporate shareholders do not have to pay self-employment tax since they are not self-employed.  Shareholders who are also employed by the company pay Social Security and Medicare tax on their wages. Conversely, members of an LLC are viewed as self-employed persons who must pay self-employment tax on their share of the LLC’s profits each year.

6. Liability protection

Although both entities offer the same liability protection, there are differences in how the entities are organized and taxed. Historically, corporations have established set organizational structures, while LLCs lack a concrete composition.  Owners in both businesses are protected from personal liability for lawsuits and business debts. Should the business face lawsuits, the owner's personal assets are safe.

When is it best to choose a corporation?

• If you plan on bringing outside investors. Corporations typically have uniform management systems and easy transferability of shares.
• If you are looking to benefit from tax savings offered to S corporations.
• Corporations are suitable for businesses that plan on keeping cash in the company instead of distributing everything to owners.
• If you are an owner who works in the business and want to save on self-employment taxes.

When is it best to choose an LLC?

• If you are a small business that does not look to raise capital from outside sources. 
• If you enjoy more freedom in the profit sharing of the LLC as distributions may be distributed however you see fit, even if it differs from the percentage of ownership.
• If you dislike the hassle of compliance and additional paperwork that comes with holding annual general meetings and creating records and reports.

Key Takeaway

Both entities come with their advantages and disadvantages, and it is best to choose the one that meets your business needs, goals, and objectives. Contact us if you have any questions or need assistance in getting started with your business.