Corporation vs LLC: Which Is Right For You?
So, you want to start a business? Congratulations! That's a major decision that can lead to great success. You need to take one step first however, and that's choosing the right entity type for your business. More specifically, an LLC versus a corporation. This decision helps ensure you have the proper structure to meet your business size and needs.
LLCs and corporations (often shortened as Inc.) are two distinct classifications that have strengths and weaknesses for your business needs. We are here to help make the right decision for your future business and decide which one is right for you.
Difference Between LLCs and Corporations
LLC stands for limited liability company. There are many similarities to a corporation, but you'll find more flexibility in management and taxation with an LLC, and it will have fewer recordkeeping requirements.
Corporations offer a predictable structure and offer easy transferability of shares, which is an important feature if you plan to seek outside investors.
Both LLCs and corporations are business entities created by filing documents with the state. And they each provide their owners with the same type of liability protection. Owners are generally not personally responsible for business obligations of either LLCs or corporations.
The structures for an LLC and a corporation are different. LLC owners are called members. Each member owns a percentage in the business, known as membership interest. Other LLCs, individuals, foreign individuals, corporations and other LLCs can own membership interests in LLCs. The ownership of an LLC will be outlined in the business' operating agreement (can also be called a company agreement), including details on what percentage each member owns, how the business operates, and how the company will deal with new or departing members. If an LLC does not have an operating agreement, it will act according to state law. And in some states, an LLC will need to be dissolved if a member leaves, with the option of remaining members forming a new LLC.
As for a corporation, it's much different. Corporate owners are known as shareholders. Their ownership percentages reflect the number of shares of company stock they own. A corporation can authorize additional shares, or they can transfer their shares to someone else for stakeholders.
The management side of both is also different. LLCs can be managed by their owners/members known as member-managed or controlled by one or more managers known as manager-managed (BetterLegal’s operating agreement uses the manager-managed type), with the members acting as passive investors. The people who run an LLC do not necessarily have to adhere to traditional role titles like a CEO but can change their management structure that works for their business needs. It's very fluid and up to you.
Versus a corporation, it operates with a much stricter management structure. A board of directors will oversee the business and officers who manage the daily operations. Shareholders also must meet once a year. You don’t have much flexibility in management titles and changing up the structure in a corporation as you would an LLC.
The tax side is where things really differ between the two. And it's vital to fully comprehend the taxes involved with each so you know what would best fit your business. It is a complicated topic that you should always receive advice from an experienced accountant about the tax classification that works best for your business.
For a corporation, there are two ways it can be taxed (how the IRS views your company). One, they file a corporate tax return (C corporations) and pay corporate taxes. If shareholders take distributions from the company, they'll report these on their personal tax returns along with any company salary they receive and pay personal income taxes. The second way is by filing as an S corp. This is a way to avoid double taxation of distributions. S corps don't pay corporate income tax. Instead, the company's profits pass through the shareholders' personal returns, and each shareholder will pay individual taxes on their portion. However, you must be eligible for an S corp taxation. A corporation must have 100 or fewer shareholders and meet other ownership requirements to be viewed as an S corp.
As for LLCs, they don’t have an IRS tax classification of their own. Single-member LLCs are automatically taxed like sole proprietorships, while multi-member LLCs are automatically taxed like partnerships. Regardless of either case, company profits pass through the members, and the members pay income and self-employment taxes on their share. But an LLC can elect to be taxed as a C or S corp., if it qualifies.
To reiterate because it’s such a confusing idea; an LLC can be viewed/taxed by the IRS as a sole proprietorship, a partnership, a C corporation, or an S corporation. This flexibility is partly why LLCs are the dominant entity type in the US.
The final piece of information you need to understand on making your decision for your business is legal liability. Both corporations and LLCs are limited liability entities, meaning the owners are not personally liable for business debts or lawsuits against the company. However, business owners do remain liable for their own negligence.
It's crucial to keep business, and personal finances separate to maintain liability protection for both LLCs and corporations. An owner should sign any documents or contracts on behalf of the company, not themselves. And a corporation needs to include corporate minutes, details on shareholder meetings, and information on its board of directors.
Corporations and LLCs need to make required filings and reports to the state to stay in good standing. You should maintain a registered agent to update the agent information on file as necessary. The majority of states will require both to file an annual report or franchise tax report to maintain an active business status. Corporations will always have more paperwork required to be filed.
Make your Business Entity Decision
Now that you know all the differences between an LLC and a corporation, it's time to decide which works best for you. As you can tell from reading above, there are many benefits to both. It just depends on what works best for YOUR business, not others. If you need help setting up your business, reach out to us today. We can help make this decision even more straightforward and go through key points that are difficult to understand. After all, we are here to help your business become successful, whether that be an LLC or corporation.