LLC vs. Corporation (What’s the difference?)
When starting a new business, one of the most important decisions you’ll have to make is choosing the legal structure for your company. Two of the most popular options are forming a Limited Liability Company (LLC) or a Corporation.
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While both LLCs and corporations offer limited personal liability protection for owners and can help you establish credibility with customers, they have different requirements, tax implications, and management structures. It’s crucial to understand the differences between LLCs and Corporations so that you can make an informed decision that aligns with your business goals and needs. In this article, we’ll explore the key differences between LLCs and Corporations to help you determine which structure is right for your business.
Quick summary
If you choose to pursue one of these business structures, you will want to read on for all the details of each option. This will help you understand exactly how to proceed and what to consider along the way. However we also know that business owners are busy – so here is a short summary.
Most businesses are able to operate under an LLC because it offers a balance of legal protection and tax benefits. An LLC is easy to form and offers limited liability protections to the business’s owner, while still treating income as a part of their personal taxable income. In contrast, a corporation offers extensive protections but is taxed as its own entity and requires much more administrative work to upkeep.
Some services will help with the formation of your business, whether you choose an LLC or a corporation, to ensure you are making the right decisions for your business.
LLC vs. Corporation
LLCs and corporations are two of the most common business structures available to entrepreneurs in the United States and have many similarities. Each version also has pros and cons that should be balanced against your business needs, goals, and how it will be structured. Before you can make the decision on whether an LLC or corporation is right for you, it is important to understand how each of them works.
LLC
An LLC, or limited liability company, is a business structure that allows owners to maintain a separation from their business. This means that when a business has financial obligations, debts, or payments as a result of a lawsuit, an owner’s personal assets cannot be seized to meet those obligations. In contrast to something like a sole proprietorship, this allows for protection for the LLCs owner or owners.
LLCs can be structured as a single-member LLC, in which there is only one owner. When there are more than one owner, it is called a multi-member LLC. The IRS treats LLCs similarly to the way they treat sole proprietors, meaning that income and expenses are reported on the owner’s personal tax returns. This is known as “pass-through” taxation and avoids higher corporate income tax rates or double taxation for owners.
The exact process to start and maintain an LLC will vary by state law, but it is typically very simple. Basic steps like filing articles of organization, registering your business name, and assigning a registered agent are common requirements.
Best for: An LLC is primarily chosen for the legal protection of personal assets, so any business with multiple clients and large amounts of money will benefit. However, this protection is limited, so extremely large organizations or ones that want total separation of assets may prefer a corporation. An LLC is also a good choice for businesses with one or a few owners who do not need to operate under the guidance of a board of directors or shareholders.
Advantages of an LLC
There is a reason LLCs are so popular: they come with a lot of benefits! For many people, this far outweighs any negatives there may be, especially the tax advantages. You can decide for yourself based on these advantages.
- Taxation: When a business is an LLC, there is more flexibility than other business structures. While you can choose to be taxed as a corporation, most LLCs will claim business income on the owners’ personal taxes as a pass-through entity. This avoids most additional taxes that corporations would face.
- Liability protection: If a business is held liable for any debts, lawsuits, and other obligations, an LLC offers protection to the owner so they are not personally held to account for these obligations.
- Ease of setup: Setting up an LLC usually requires some simple paperwork and a small fee, rather than extensive requirements like a corporation may have.
- Market credibility: An LLC must denote that it is one in the title, so most customers will recognize that your business is a legal, authorized entity type and trust you to do business with them.
Disadvantages of an LLC
Of course, there are reasons that an LLC may not be the best fit for every company. There are some downsides that may make a corporation the better option for you.
- Taxation: Owners of an LLC are considered self-employed, so they will need to pay self-employment taxes on all income. These may or may not be higher than corporations’ taxes depending on their tax status and whether they pay things like withholding tax for Medicare and Social Security.
- Growth potential: LLCs cannot issue stock or sell ownership shares of stock, which can make it harder to raise capital for growth in a startup.
- Perpetual lifespan: When a member of the LLC leaves or dies, the LLC needs to be restructured or dissolved as it is tied to those individuals. A corporation exists in perpetuity regardless of ownership.
- Liability protection: While an LLC offers liability protection, there are instances where it will not be covered. This protection extends only to owners and can be overridden if the company is found to be behaving illegally or unethically.
Corporation
While you may associate corporations with large, multinational companies, anyone can start a corporation. These businesses are run with more complex leadership structures, which include investors and shareholders along with a Board of Directors. All of these positions must be delineated and created during the formation process, which includes handing over meeting notes and an operating agreement to prove the business is operating correctly.
Corporations are separate entities from any of their owners, so there is complete asset protection in almost every circumstance. This delineation also means that business profits and losses cannot be treated as personal taxes, and the corporation will file independently.
Best for: A business with multiple owners who brings in large investments and client bases may benefit from incorporation. Any business that wants to sell stock will also need to be a corporation.
Advantages of a corporation
A corporation may not be the best choice for every business, but there are some major advantages to the structure for those that need them. Financial, administrative, and protective benefits are all key factors in this decision.
- Taxation: Profits and losses are taxed to the corporation itself, rather than any individual. This means there may be a higher tax rate, depending on the location and size of the business, but also avoids costly self-employment taxes and can streamline filing for tax purposes.
- Liability protection: A corporation can be sued as its own legal entity. Shareholders, directors, employees, and owners will not be held responsible for any legal obligations or debts the business owes.
- Flexibility: Since a corporation is not tied to a single owner, it can easily change hands without needing to restructure.
- Access to funding: Corporations are allowed to sell stock, which no other type of business can. This makes it easy to grow the business and raise capital quickly.
Disadvantages of a corporation
Most businesses will not choose to become a corporation, because the disadvantages can be burdensome.
- Taxation: While a corporation pays its own taxes, each shareholder will then pay personal income taxes on distributions. This is often referred to as double taxation, which can be expensive.
- Long application process: Forming a corporation has many required steps, including drafting long documents and creating a board of directors, along with filing articles of incorporation. This can take a long time for some businesses.
- Rigid rules: Corporations must follow a number of formalities and regulations in order to maintain their status, like hosting an annual shareholder meeting and recording minutes. This record-keeping be time-consuming and expensive for small businesses, compared to something like an annual report that is simple for LLCs to submit.
LLC vs. Corporation – Final word
You know your business best and will hopefully now have a sense of the best option for you. Corporations and LLCs are both great options, but depending on your business’s needs, industry, structure, and goals one may be a better fit. The majority of companies can benefit most from an LLC, but when a corporation fits the bill, it can be extremely beneficial as well.
FAQs
Is an LLC or a corporation more expensive to start?
The cost to form any business will vary by the Secretary of State’s rules, but generally, the fee to start an LLC and a corporation are similar. However, corporations often have more requirements for upkeep and can cost more money over time due to these state fees. It can also be more expensive to raise capital which allows for the selling of stocks in a corporation.
Does an LLC offer the same protection as a corporation?
An LLC does offer asset protection, but it is generally limited to the owner or owners’ investment in the company and personal assets. A corporation is decoupled from the owners entirely and protects shareholders as well, so has a bit broader reach of protection. There are rare cases when both LLC and corporation owners can be held personally liable.
Are LLCs and corporations taxed the same?
An LLC can be taxed as a corporation, but does not have to be, Corporations are individual entities that pay taxes at a corporate rate. If an LLC elects to be treated as a pass-through taxation entity, the owner or owners will claim profit as personal income on their own taxes.
Are there different types of corporations?
Yes. A C corp or C corporation is the standard, but some businesses are able to file as other types, with the most common being an S corp. An S corp allows for pass-through taxation so long as there is only one class of stock, they only issue shares to 100 or fewer people, and it is started by a U.S. citizen.
