One of the first steps to take in starting a business is determining your business structure. If you want personal liability protection the choice often comes down to an LLC vs Corporation. While both provide liability protection for their owners, they have a variety of differences that impact daily operations, ongoing costs, investment opportunities, and how taxes are paid. In this LLC vs Corporation comparison guide, we’ll go over how LLCs and Corporations are similar and their main differences so you can choose which is the best fit for your business.
Before we get into the weeds of comparing and contrasting LLCs and Corporations, it’s important that you understand what they are. Below is a brief definition of what each are:
- What is a Corporation?
Corporations, commonly referred to as a “C-Corp” are a formal business structure that is recognized as a separate legal entity from their owners, who are known as “shareholders”. Because a Corporation is recognized as a separate entity from its owners, they provide strong personal liability protection for their owners.
- What is an LLC?
The acronym LLC stands for Limited Liability Company, which is a business entity that is managed and owned by “members”. LLCs are a newer business entity that was first established in the 1970s, primarily to provide a formal business structure option for small businesses. LLCs are flexible entities that combine the limited liability protections of a corporation with the pass-through taxation that sole proprietors and partnerships have.
The main reason that LLCs and Corporations are often compared to each other is due to the similarities the 2 entities share. Both Corporations and LLCs are formal business entities that are created by filing legal paperwork with their state’s Secretary of State office. Since both are formal business entities they are recognized as legally separate from their owners. As a result, they both offer limited liability protection for their owners (although the protections offered by a Corporation are often stronger than those offered by an LLC, in most cases).
What is Liability Protection and Why does it Matter?
Just like people can be held accountable for their actions, so can businesses. This is where personal liability comes into play. Since LLCs and Corporations are recognized as separate entities from their owners, it protects the business owners from being held personally liable (personally responsible) for certain debts or legal obligations from being sued. This can be extremely important for the business owners as it prevents creditors or litigants from going after the owner’s personal assets, like their car, home, and personal bank accounts. In contrast, businesses that operate under informal structures like sole proprietorships and partnerships have unlimited liability risk.
The easiest way to determine if it is better to have an LLC or corporation is to compare the overarching difference between LLCs and Corporations. The main differences between these two business structures include the following:
A closer look at each of these differences will help you determine which business entity is right for you.
As formal business structures, Corporations and LLCs require that paperwork be filed with their state’s Secretary of State office to be legally recognized. While both require formal paperwork to be filed, the documents and information required for each differ slightly.
Forming an LLC
LLCs are formed by filing Articles of Organization (some states refer to the formation document as a Certificate of Formation or Certificate of Organization) with the Secretary of State’s office in the state where the business will operate. While the exact requirements will vary slightly from state to state, generally an LLC will need to provide the following pieces of information:
- Name of the LLC that includes the word “Limited Liability Company” or a relevant designator such as “LLC” to ensure that people are aware the business is formed as an LLC.
- A physical business address (not a PO Box)
- A Registered Agent
In addition to filing the Articles of Organization document, an LLC will also want to create an Operating Agreement that will define the daily activities and responsibilities of any managers or members. The operating agreement also outlines the initial investments of each member, their ownership percentage and provides a process for how disputes can be resolved. Beyond this, LLC has very few other requirements or obligations, outside of the filing of an Annual Report or Franchise Tax to keep their business in good standing with the state.
For more a more detailed look at the LLC formation process check out our step-by-step guide:
How to Start an LLC
Forming a Corporation
The process of forming a Corporation is fairly similar to that of an LLC. Corporations are formed by filing Articles of Incorporation with the Secretary of State’s office. The Articles of Incorporation often require more information to be provided than an LLC. Requirements will vary slightly from state to start, however they generally require the following information to be provided:
- Name of the Corporation that includes the phrase “Incorporated” or the abbreviation “Inc.” or another approved designator that clearly designates that the business is formed as a corporation.
- Name and Address of the Registered Agent
- Type of Corporation
- Number and Value of Authorized Shares
- Names and Address of Directors
Since Corporations are a more formal type of business structure they are required to form a board of directors and designate individuals for specific roles like President, Vice President and Secretary. During the initial board of directors meeting, a corporate bylaws document should be created as well. The corporate bylaws is a document that outlines the rules and guiding principles of the corporation. The corporate bylaws document is very similar to an operating agreement for an LLC, however they are often required by law while the operating agreement is not, in most states. With the more formal nature of the bylaws document its highly suggested that you seek the assistance of a lawyer or professional service to assist with the creation of the corporate bylaws document.
If you’re intested in getting more details on the process to form a corporation visit our guide:
How to Incorporate: 6 Steps to Form a Corporation
Ownership and how owners are designated differs between an LLC vs a corporation. In fact, the ownership structure is a significant factor in a business owner’s choice whether it’s better to have an LLC or a corporation.
The owners of an LLC are formally referred to as “members”. LLCs can be owned individually, by a corporation, or even by a trust. Single-member LLCs are owned by a single individual who also serves as the manager of the business. For LLCs with more than one owner, the organization is often considered a partnership.
Members of an LLC are not part of a Board of Directors, and they do not need to vote or formalize their business decisions. It is beneficial for members to create an Operating Agreement, however, to formalize their structure and process. Without an operating agreement, if a member chooses to step away from the LLC, the business may need to be dissolved if a resolution is unable to be reached between the LLC members. With an operating agreement in place, members can choose how to transfer ownership in case one member decides to leave. This helps maintain the longevity of the business beyond the working lifespan of a single member.
The operating agreement also helps keep the LLC within the “corporate veil,” meaning the business dealings are kept separate from the members’ private dealings, ensuring their liability protection should the business struggle.
Within a corporation, the owners are referred to as “shareholders.” This is because each owner has a share of ownership within the corporation.
The ownership structure of a corporation, while much more formal than an LLC, can ensure the longevity of the company. When a shareholder decides to step away from the corporation, the business doesn’t have to dissolve. Corporations are structured to handle the smooth transfer of ownership from one shareholder to the next.
Shareholders are not often involved in the day-to-day running of a corporation. Instead, shareholders elect the Board of Directors that will manage the corporation. It is possible for shareholders to be elected to the board or serve as corporate officers in the business. How this works for each corporation depends on their bylaws.
How a business entity handles profits and losses is largely tied to its taxes. LLC vs corporation taxes varies from business to business. Especially since an LLC can actually elect to be taxed like a corporation.
Apart from taxes, there are two things that separate how an LLC vs corporation deals with profits or losses each year.
LLC Profits and Losses
In an LLC, the members receive the profits as part of their income. How those profits are dispersed depends on their structure. For example, if the LLC made a profit of $100,000 and has two equal members, they would both receive $50,000. This money is then reported on their individual taxes and taxed accordingly.
If the LLC experienced a loss, this also gets noted on the individual tax returns of each member.
Corporate Profits and Losses
Corporations function differently in that the profits of the organization can either be put back into the organization (to build, buy new equipment, or invest in new products) or it can be paid out in dividends to the shareholders.
When a shareholder receives a dividend (based on the number of shares they own), they then must report that money as income on their tax returns.
Losses impact shareholders directly in that the value of their shares can decrease. Many corporations are structured to value shareholder profit above anything else.
Taxes play a key role in differentiating an LLC from a corporation. Corporations are taxed as a separate entity—meaning the business pays its own income tax on profits. An LLC, however, can be taxed in several ways.
An LLC is most frequently taxed like a partnership or sole-proprietorship. These tax entities experience “pass-through taxes,” meaning the profits pass through to the members and are taxed through their individual tax returns.
Members of an LLC must pay self-employment taxes on top of income tax, which can produce a hefty tax burden on individual owners.
For LLCs that are experiencing a nice profit, however, the members can elect to be taxed as an S-corporation. This allows them to still experience pass-through taxes on their individual income (the salary they pay themselves from the LLC). However, any additional profits can be paid to the members as dividends to avoid self-employment taxes. This is just one way LLC flexibility is beneficial for small businesses.
LLC vs corporation taxes differs in that corporations are either taxed as a C-corporation or S-corporation. And not all corporations can elect one over the other. In a C-corporation model, the corporation itself pays income tax on any profits. When those profits are sent to shareholders as dividends, the shareholders then also pay tax on that income. That is the double-taxation that many corporations find frustrating.
S-corporation taxes can avoid double taxation because the profits are not taxed prior to being passed to the shareholders. The shareholders are still responsible to pay individual taxes on the profits given to them.
Is it Better to Have an LLC or Corporation?
The difference between LLCs and corporations can help you determine with business structure is right for your organization. Some of the questions that you can ask yourself to help in this decision are:
- Do I want to involve investors in the future of my company?
- Will there be more than one owner involved?
- Is this a low-risk or high-risk business?
- Is this a low-profit or high-profit business?