Key Takeaways

  • Corporation vs LLC: Both provide liability protection but differ in ownership, taxation, and formalities.
  • Ownership: Corporations have shareholders; LLCs have members with more flexible ownership structures.
  • Management: Corporations require directors and officers, while LLCs allow member-managed or manager-managed models.
  • Taxes: C corporations face double taxation; LLCs and S corps are generally pass-through entities.
  • Growth potential: Corporations suit businesses seeking investors or public offerings; LLCs fit smaller, closely held businesses.
  • Formality: Corporations require bylaws, stock issuance, and annual meetings; LLCs have fewer administrative requirements.
  • Conversion options: An LLC can elect corporate taxation for strategic benefits.

Corporation vs LLC

Corporation vs LLC are separate legal entities from the individuals that own and manage them. The owners of corporations (shareholders) and LLCs (Members) are both protected from individual liability for the debts and liabilities of the company. Corporations and LLCs can only be created by filing appropriate paperwork with the state. The filing requirements are more stringent for corporations.

Traditional C corporations pay taxes; however, LLCs and S corporations both typically act as “pass-through” entities wherein the profits, losses, and tax burden pass directly to the owners. S corporations always need to file a business tax return. LLCs file a business tax return whenever they have more than one Member. However, no income taxes need to be paid by pass-through entities.

LLCs and S Corps are both pass-through tax entities by default. S corps always must file a business tax return. LLCs do not need to file a business tax return if there is only one Member.

Differences in Ownership and Formalities

Corporations are owned by shareholders, LLCs are owned by Members. There are many more restrictions imposed on the ownership of corporations. An LLC can distribute ownership to members in any way the Members would like. Corporations are generally required to distribute ownership strictly based upon the percentage of stock owned (although, unique class structures can be created in a C corporation).

S corporations are limited to no more than 100 shareholders, and can only be owned by individual United States citizens or resident aliens. S corporations must also have a single class of stocks. LLCs can be owned by any legal entity.

There are a number of formalities that corporations must adhere to, including holding annual meetings, maintaining a Board of Directors, adopting bylaws, issuing stock, and keeping records. LLCs have few administrative requirements.

Transferability of Interests

In a corporation, ownership interests (shares) are freely transferable, which makes it easier to bring in investors or sell a portion of the company. By contrast, transferring ownership in an LLC often requires approval from other members, unless the operating agreement states otherwise. This makes corporations more attractive to venture capitalists and investors who want liquidity, while LLCs are typically better for businesses where ownership is kept within a small group of individuals.

Differences in Management

LLCs are very flexible in how they can be managed. Members can choose to manage an LLC themselves, appoint others to manage the LLC for them, or structure any combination thereof. Corporations, on the other hand, typically have a strict distinction between the owners and the management. In a corporation, a Board of Directors that oversees the major decisions of the company is typically required, and a team of executive officers usually handles the day-to-day operations.

Continuity and Duration

Corporations are perpetual entities, meaning they continue to exist regardless of changes in ownership or management. LLCs, however, may be dissolved upon the death or withdrawal of a member unless the operating agreement provides for continuity. This distinction makes corporations better suited for businesses planning long-term growth and succession planning.

Other Differences

Corporations exist perpetually by default, but in some states, LLCs are required to have dissolution dates. When a Member leaves an LLC, in some cases, it can cause the LLC to dissolve.

It is much easier to transfer ownership of a corporation as compared to an LLC. Selling and transferring stock is easy; selling membership of an LLC is governed by the Operating Agreement, but can be difficult or impossible sometimes. In an S corporation, shareholders that work at a company can be treated as employees and pay employment taxes.

Record-Keeping and Compliance

Corporations must follow strict compliance rules, including adopting bylaws, issuing stock certificates, and holding annual shareholder and director meetings. LLCs face fewer formalities, typically requiring only an operating agreement and basic record-keeping. However, even LLCs benefit from maintaining accurate financial and operational records to preserve liability protection.

LLC vs. Corporation: Other Key Differences

S corporation owners are permitted to deduct business losses on their personal income tax returns. S corporations can thus save owners money on taxes compared to C corporations, which are taxed as a separate entity.

LLCs and C corporations can have an unlimited number of owners; S corporations are limited to 100 shareholders. Because it is so easy to sell and transfer stock, C corporations are the preferred choice of many growing businesses. C corporations also offer the ability of different stock classes (i.e., preferred and common stock), which allow for more investment opportunities.

C corporations can carry profits and losses over to the next year to help with the tax burden. LLCs and S corporations typically do not have this option.

Raising Capital and Attracting Investors

Corporations, particularly C corporations, are often the preferred structure for companies seeking outside investment. Venture capital firms, angel investors, and private equity groups generally require a corporate structure because of the ease of issuing different classes of stock. LLCs can raise capital, but the process is less standardized, and some investors are hesitant due to pass-through taxation and transfer restrictions.

Corporations vs. LLC's - Tax Differences

C corporations are taxed as separate entities. Shareholders are also taxed individually when they receive dividend payments. This is why C corporations are said to face “double taxation.”

LLCs and S corporations are also legally separate entities, but they are not taxed. Instead, the tax burden “passes through” to the owners who pay taxes on company profits individually.

Corporate and LLC Owners and Taxes

When corporate shareholders receive dividends, those dividend payments are considered personal income and they must pay taxes on them. LLC members, meanwhile, receive company profits directly in the form of income and must pay taxes on that income.

Legal Entity vs Tax Entity

A legal entity has independent legal rights, but being a legal entity does not necessarily make a company a tax entity. Whether something is a tax entity is determined by IRS and state tax agency classifications. C corporations are a separate tax entity and are taxed by the IRS. S corporations and LLCs are typically not separate tax entities. Profits from S corporations and LLCs are paid by the individual owners.

Legal Discrepancies

Corporations have been around for centuries, but LLCs have only been accepted since the 1970s. Today, every state accepts LLCs. Corporations have distinct features and requirements from LLCs. The most important legal distinction is that LLCs are not incorporated, and thus the formal requirements involved with issuing stock and having a Board of Directors do not apply to LLCs.

Taxes

Corporations suffer from double taxation. Corporate profits are taxed, and shareholders pay taxes on dividends they receive. S corporations and LLCs are not double taxed; only the individuals pay taxes on company profits.

Employment and Self-Employment Taxes

Owners of LLCs treated as partnerships are subject to self-employment taxes on their share of business income, which can increase the overall tax burden. In contrast, corporation shareholders who are also employees pay FICA taxes on their wages but not on dividends. S corporations offer a hybrid advantage, as shareholders can pay themselves a “reasonable salary” subject to employment taxes while taking the remainder as distributions that are not subject to self-employment tax.

A Third Possibility - An LLC Taxed as a Corporation

It is possible to elect to have an LLC be taxed as a C corporation. For some LLC owners, paying a lower corporate tax rate on profits and then paying taxes again individually for income payments is better than paying all of the taxes according to the owners’ individual Adjusted Gross Incomes.

What is Incorporation?

Incorporating a business means that your business is formally recognized by the state as a corporation. Certain rights, as well as responsibilities, attach when a business is incorporated. When a business is incorporated, ownership is transferred to shareholders, management is vested in a Board of Directors, and state administrative requirements must be adhered to.

How are LLCs and Corporations Formed?

One of more people can form an LLC or corporation by filing paperwork with the Secretary of State of the state where the business will be headquartered. Corporations must file Articles of Incorporation; LLCs must file Articles of Organization. Corporations require Bylaws and a Board of Directors; LLCs require an Operating Agreement. When a corporation is formed,

Costs of Formation and Maintenance

The cost to form an LLC or corporation varies by state. Generally, LLCs are less expensive to set up and maintain because they have fewer ongoing compliance obligations. Corporations, while sometimes inexpensive to form, can incur higher long-term costs due to annual filing requirements, franchise taxes, and record-keeping. Business owners should compare both the initial filing fees and the recurring compliance costs when choosing between an LLC and a corporation.

Limited Liability Company Benefits

As with shareholders of corporations, Members of LLCs are not personally liable for debts and liabilities of the company. So, if an LLC loses a lawsuit, personal assets of Members are not at risk.

LLCs are very flexible in how they can be managed. Unlike corporations, which have stringent management and administrative requirements, LLC Members can choose to operate and manage an LLC almost however they want.

Limitations of LLCs

Although LLCs provide flexibility and liability protection, they may not be the best choice for businesses aiming for rapid growth or public offerings. Some states also impose higher fees on LLCs, and certain industries or investors may prefer corporations due to their predictable structure. LLC members also face potential challenges with self-employment taxes and limited continuity compared to corporations.

Why is an LLC NOT a Corporation?

An LLC is a “Limited Liability Company.” It is not a corporation as an LLC is not incorporated.

Is an LLC Right for You?

Small business owners and entrepreneurs often find that LLCs are the best choice because they can be managed much more flexibly, are cheaper to establish and maintain, and are better for tax purposes because they are not double taxed.

Is a Corporation Right for You?

While LLCs work great when there are only a few owners of a business, when there are many investors that all want a say in what happens, corporations can provide a better management structure. Corporations are also better for growing businesses that are seeking new investors because they can offer stock. Finally, corporations can provide a number of excellent benefits for shareholders that are also employees.

Is an S Corporation Right for You?

S corporations are not taxed, and instead, owners pay self-employment taxes for their compensation.

Frequently Asked Questions

1. Which is better for small businesses: a corporation or an LLC?

An LLC is usually better for small businesses due to flexibility, lower costs, and pass-through taxation. Corporations are more suitable for businesses seeking investors.

2. Can an LLC be converted into a corporation later?

Yes. An LLC can convert into a corporation if the business grows and needs to raise capital or issue stock. The process varies by state.

3. Do corporations really pay more taxes than LLCs?

C corporations face double taxation, while LLCs usually avoid it through pass-through taxation. However, S corporations and tax elections can reduce burdens.

4. Are LLC owners considered employees?

No. LLC members are generally considered self-employed, not employees. By contrast, corporation shareholders can also be employees.

5. Which entity is better for liability protection?

Both LLCs and corporations provide strong liability protection for owners, shielding personal assets from business debts and lawsuits.

If you need help with creating a contract, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.