As a business owner, one of the first starts towards forming a new company is determining the right structure for your business. Two of the most popular structures are limited liability company (LLCs) and corporation. While there are some similarities between them such as personal liability protection, there are also quite a few differences.
Depending on your company's unique needs, one of these business structures may be considerably better suited to your situation. Read on to determine which structure is the best fit for your business.
Recommended: Read our guide on the Best LLC Formation Services.
LLC vs Corporation: Similarities
The most important mutual characteristic of LLCs and corporations is the protection of your personal assets or liability protection. If your business is sued, creditors cannot pursue your own personal property or money to satisfy business debts thanks to the protections afforded to you by your company.
Of course, this limited liability protection is not foolproof — you still need to properly form and maintain your company in order to ensure a separation from your personal assets and business assets.
Both LLCs and corporations also protect your unique business name from being used by other companies and allow your business to exist in perpetuity. This means that, unlike sole proprietorships and partnerships, your company can usually survive beyond its owner's departure.
While these similarities are important, there are far more ways in which LLCs and corporations differ.
LLC vs Corporation: Differences
From the start, there are major differences in the way LLCs and corporations are formed. Forming an LLC is quite simple in most states. While the process can differ slightly from state to state, generally speaking the only true requirement when forming an LLC is filing your articles of organization. This document provides the basic details of your company and identifies you to the state.
However, when forming a corporation, you will need to accomplish the following steps:
File Articles of Incorporation & Corporate Bylaws
These are important documents that describe the vital details of your corporation. What is the company's name? Where is it located? What kind of business is it? Who are the shareholders? These are just a few of the questions that should be answered by these documents.
Determine Organizational Resolutions
Next, you'll need to determine items such as who to appoint as your corporation's officers and how you want to issue stock to your shareholders. These are called organizational resolutions, and depending on the size of your company and the nature of its business, you may need more than a dozen of these important resolutions to complete organization.
Assemble a Board of Directors
Your corporation's board of directors will represent your shareholders. Because many corporations have too many shareholders to get them all in one room (and have their individual voices heard), they must name directors to draft objectives and company policies, approve budgetary issues, and make other important decisions for the business.
Distribute Stock Certificates
This step involves providing ownership shares to all shareholders.
Limited liability companies are owned by their members. The ownership of an LLC is outlined in your LLC operating agreement. While there must be at least one member, there is no upper limit to the number of members an LLC may have.
The LLC's profits can be split among these members any way they choose, regardless of the amount of money each member contributed at formation. There are no set rules that guide the way members divide their profits, giving you great flexibility in how your profits are distributed.
By contrast, corporations are owned by their shareholders and do not require an operating agreement. Depending on which type of corporation you operate, c corporation or s corporation, the number of shareholders may or may not be limited. While there is no limit on the number of shareholders a C corp can have, an S corp can have no more than 100 shareholders.
Additionally, while C corporations can create unique stock classes in order to split profits however they please, just like LLCs, an S corporation can only have one uniform class of stock.
LLCs have two options for management structures: member-managed or manager-managed. This means that the company can be managed either by a member or members, or name a separate manager who is not a member. Additionally, when running a limited liability company, you do not have to adhere to specified roles such as CEO or President.
The management structure of a corporation, however, must adhere to a proper corporate structure. The board of directors handles big-picture managerial decisions, while corporate officers handle the daily affairs. This is a much more rigid and decentralized system.
LLCs are a fairly new business structure, having only been around for a few decades. As such, many of the laws that govern these businesses are more recent and have not been through many court cases to establish legal precedent.
Therefore, there is still room for interpretation in many of these laws. Furthermore, variation exists from state to state regarding formation and maintenance. For this reason, if you operate your LLC in multiple states, you may need to adhere to a different set of rules and regulations in each one.
Alternatively, the corporation as a legal entity has existed for hundreds of years and because of this, the laws regarding how corporations are treated are quite clear. In addition, laws governing corporations are uniformly applied across the nation, leaving little room for debate regarding interpretation, and making implementation easier to follow across state lines.
Need Help Forming a Corporation? Check out our Best Incorporation Services for Startups to get started.
How Do LLCs and Corporations Differ as Tax Entities?
Beyond the issues tied to forming an LLC vs corporation, comparing taxation models for these business structures can be even more complicated. One reason for this is that there are a few different ways corporations, and its shareholders, can pay taxes. Below, LLCs are compared to the two main corporate tax structures: C corporations and S corporations.
One major factor that separates LLCs from corporations when it comes to taxation is that LLCs can choose how they want to be taxed. Most LLCs follow a pass-through model of taxation, otherwise known as being a pass-through entity, which means the company's profits and losses are not taxed on a corporate level, but instead are passed on to the LLC members to claim on their personal tax returns.
It's also important to note that as a pass-through entity, the members of an LLC are often subject to self-employment tax. This tax rate sees an individual pay both the employee and employer portions of social security and Medicare, which means a 15.3% tax rate. However, an LLC may also choose to be taxed like a C corporation or an S corporation.
C Corporation Taxation
The C corp is the more common designation for corporations, because the rules and regulations for maintaining it are far less strict than those of an S corp. One downside of C corps, though, is that they're subject to double taxation.
This means that your profits are first subject to taxation at the corporate level, otherwise known as corporate income tax and currently set at 21%. Then taxed on your personal tax returns as well. Though you will not be required to pay self-employment tax on your profits under this model, the double taxation can create a large tax burden.
S Corporation Taxation
In a way, the S corporation tax designation is like a compromise between LLC and C corp taxation models. Similarly to an LLC, an S corp's taxes are passed through to its shareholder's personal tax returns and not taxed at the corporate level, thus avoiding the double taxation that applies to C corps. The major difference between an S corp and an LLC is that the S corp's dividends are not taxable, while the profits of the LLC are.
While this form of taxation can create a significant advantage for S corps, it's important to note that this tax structure is not available to everyone. Among other details, your business must adhere to the following guidelines to qualify for S corp taxation:
- May not exceed 100 shareholders
- May not issue more than one class of stock
- May not have shareholders who are not U.S. citizens/residents
- May not be owned by another business
If your business fits these requirements, it's easy to see why many prefer the S corp tax designation. It really can be the best of both worlds for many companies.
LLC vs Corporation: Which Should I Choose?
As you can see, there are quite a few important differences between LLCs and corporations.
Depending on the details of your business entity, one of these structures will fit your company better than the others, both in terms of forming and maintaining a successful business, personal liability protection, and establishing the most favorable tax structure for maximizing profits.