LLC vs Corporation: Which Structure Is Best for Your Small Business?
Last Updated: January 12, 2023
The LLC vs corporation dilemma is pretty common among inexperienced entrepreneurs deciding on the right business structure for their small enterprise.
You may already know that both options offer a certain level of personal liability protection. But what’s the difference between an LLC and a corporation?
Here’s a hint: It’s all about the entity’s ownership structure, organization, and tax obligations.
Let’s take a closer look!
What Is an LLC?
Before going into an LLC and corporation comparison, we need tо definе the terms.
Right off the bat, LLC is an acronym standing for Limited Liability Company. This type of business entity combines some of the best features of sole proprietorships, partnerships, and corporations into one legal business structure. Namely, it gives entrepreneurs the simplicity of running a sole proprietorship with the liability protection of a corporation.
LLC benefits and downsides
As we’ve said, the corporation vs LLC choice isn’t as simple as it may seem. To decide between the two structures, you need to be aware of their pros and cons.
So let’s start with the advantages and disadvantages of an LLC!
The main reasons why people choose to register a business as an LLC are:
- Personal asset protection:
If your business gets into debt, creditors will not be able to lay claim on your personal assets. In other words, as an LLC member, your bank account, home, vehicles, etc., are safe from repercussions.
In terms of taxation, the number of LLC members is a determining factor. For example, the Internal Revenue System (IRS) treats a single-member LLC as a sole proprietorship. And a two-member proprietorship is seen as a general partnership.
Still, you shouldn’t base your LLC or corporation decision on tax obligations alone. This is because some of the largest LLCs have the option to pay taxes as if they were either C or S corporations.
There’s no limit to the number of members that an LLC can have. As we’ve already stated, there’s also no restriction to the way in which an LLC pays taxes. So, in theory, an LLC could have hundreds of members.
Registering and operating an LLC is simpler than running a corporation (of any type). In addition, there are also specialized LLC services that offer assistance in the formation process.
The difference between a corporation and an LLC (in this particular point of comparison) is that an LLC doesn’t need a shareholder board, meetings, officers and directors to run. The corporate structure of a corporation is far more rigid.
Simply put, an LLC is more credible and trustworthy than a sole proprietorship. From the marketing standpoint, it’s the right decision to make.
And here are some reasons why people choose against registering their entity as an LLC:
Registering and running an LLC can be somewhat expensive. The cost of the corporate tax rate depends on the state. So do the annual fees. They range between $0 in Ohio (and some other states) and $800 in California.
- Outside investments:
If you’re looking to attract outside investors, you might find that in an LLC vs corporation comparison the latter is a superior option. This is because corporations have a clearer corporate governance structure, which is a sought-after feature for investors.
What Is a Corporation?
A corporation is a business entity that provides the owner(s) with a legal separation from their business (unlike sole proprietorships and single-member LLCs).
In many cases, the law treats a corporation like a natural person (for legal purposes). So, for instance, a corporation can get a loan, sue, be sued, hire employees, own assets (that are not directly owned by entrepreneurs behind it), etc.
What type of corporation should I form?
There are several types of corporations in the US. The most common two are C corporations and S corporations. Let’s flesh them out!
C corporation vs S corporation
The three most significant differences in this comparison are the issues of:
When registering a corporation, a C corporation is the default option. So, if you want to set up an S corporation, you need to make a special request. The same applies if you start out as an LLC and switch into an S corporation.
C corporations are subject to double taxation. First, the entity pays taxes when it earns money. And second, individual shareholders/members pay taxes for making personal profit. This is because the IRS and the law treat corporations as natural persons. By contrast, both S corporations and LLCs are pass-through entities in terms of taxation.
S corporations are limited to 100 shareholders, all of which have to be US citizens. However, there are no such restrictions for either C corporations or LLCs.
Not all corporations aim to make a profit for their owners/members. Some business-like entities work for the greater good.
These organizations are often eligible for tax exemptions. Formally, they are referred to as 501(c)(3) corporations. The name stems from the IRS Code Section 501(c)(3).
And if you’ve spent time researching the nonprofit LLC vs nonprofit corporation issue, you may have found that there’s no reason in terms of taxation to choose an LLC over a C corporation. With nonprofit status, neither would pay taxes.
One more thing worth mentioning here is that if a nonprofit corporation shuts down, its assets need to get distributed to other nonprofits and not among its board members.
LLC vs Corporation: What’s the Difference?
Now let’s make an LLC vs corporation side-by-side comparison to help you get a clear idea of all the pros and cons.
|LLC||C corporation||S corporation|
|Taxation||Pass-through taxation||Double taxation||Pass-through taxation|
|Management||Members are free to set up the business structure of their choice||A formal election of a board of directors and corporate officers is required||A formal election of a board of directors and corporate officers is required|
|Personal Liability||Members are typically not held liable||Shareholders are usually not held liable||Shareholders are usually not held liable|
|Annual reports and shareholder meetings||Not required (maybe the biggest logistical difference in LLC vs corp comparison)||Required||Required|
|Publicly traded||Not possible||Possible||Possible|
|Raising capital||May sell interest according to the operating agreement||Shares or stocks can be sold to raise capital||Shares or stocks can be sold to raise capital. S corporation stock ownership is limited by its maximum number of members|
While this LLC vs corporation chart is pretty straightforward, it might be a good idea to delve a bit deeper into each of these individual comparison factors.
In this field, it seems like those behind C corporations are getting the worst deal. They pay taxes twice for the same profit (once as a corporation and once as an individual).
So, what about LLC vs S corp?
To put it simply, an S corporation is a legal business structure that allows corporations with 100 members or less to pay taxes as partnerships.
To become an S corporation, a business first needs to register as a C corporation or an LLC and then transition by meeting specific guidelines set by the IRS.
An LLC can appoint members as active managers. However, this is something that can somewhat lower the liability protection of the member in question. As an active manager of an enterprise, they are responsible for losses and debts that came into existence as a result of their decisions.
Any LLC versus corp comparison also needs to acknowledge that the structure of an LLC can be anything that the operating agreement sees as fit. On the other hand, both S corporations and C corporations need to hold formal meetings, elect a shareholder’s board and assign officers/directors. In other words, an LLC is more flexible.
Both of these entity types offer a certain degree of liability protection. However, all business-owned assets are at risk when it comes to the business’s debt.
In general, LLCs offer a bit more liability protection. Why? Well, because in some scenarios, a personal creditor of a shareholder may lay claim to their equity in the corporation. As a result, this might get them voting rights, a seat on the board, etc.
The biggest difference between LLC and corporation here lies in the fact that a personal creditor cannot lay claims on the member’s ownership in the LLC or even their management rights.
One more thing worth mentioning is the fact that this liability protection may go the other way around, as well. Namely, sometimes a business needs protection from the personal debts of shareholders, members and owners.
Annual reports and shareholder meetings
An annual report for a corporation is a mandatory document that needs to provide the shareholders with all the relevant information. It’s also a major operational requirement difference between LLC and corporation.
This information revolves around the company’s financial condition and its operations. If the corporation is publicly traded, the report must regularly disclose this information to the public.
A publicly traded or publicly listed company is a company whose shares can be freely traded on the stock exchange or OTC (over-the-counter) markets.
This can be quite profitable, but it may also cause some issues regarding the equity and ownership structure of the company.
Notably, while every publicly traded company is a corporation, not every corporation is publicly traded.
One of the most significant benefits of corporation vs LLC is its ability to raise capital in a simpler, more efficient manner. In this regard, both C corporations and S corporations are superior to LLCs.
For instance, C corporations can issue separate classes of stocks. This allows them to trade some of the equity within the company without putting the ownership structure at too much risk.
All members have voting rights in LLCs, while in C corporations, this doesn’t have to be the case. This alone makes the leadership (decision-making) structure much more clear and consistent.
S corporations, on the other hand, are ideal for attracting venture capital.
Bottom Line: Should I Form an LLC or a Corporation?
Ultimately, the limited liability company vs corporation choice boils down to your current needs and future plans.
Smaller companies are probably better off as LLCs since the formation is simpler, and there’s no double taxation. The paperwork and recordkeeping requirements are also much less with an LLC unless you seek nonprofit status. However, the transition into a corporation, later on, can be quite expensive.
On the other hand, those worried about the scalability and growth of their enterprise and the personal liability of all company owners are probably safer with a corporation. This is also the better structure for those who wish to launch an IPO or attract outside investors. In terms of taxes, as an S corporation, you can avoid double taxation, which is a significant point of concern for many potential entrepreneurs.
Most importantly, when making a comparison, it’s important to organize it as an S corporation vs C corporation vs LLC. This is because S corporation and C corporation greatly differ, and by just trying to analyze them both by a mutual term corporation, you won’t get a clear picture.
C corporations can pay more taxes than LLCs because of double taxation. Yet, S corporations pay taxes only once, the same as LLCs. Thus, for the same profit, they would pay approximately the same tax. Naturally, this is considering that all other circumstances regarding their taxation are the same to make the comparison completely safe.
C in LLC stands for company, not corporation. While both are business companies and LLCs can be treated like corporations (from a business liability standpoint), there is a difference between an LLC and a corporation. Also, both C corporations and S corporations are vastly different from LLC, and there are reasons why, in some scenarios, both of these business types are a great choice.
A company is a colloquial term for a business, while a corporation is a legal entity that, in many ways, gets treated as a natural person.
For example, a corporation can be sued, take a loan, and own assets. Also, in general use, a corporation is a term that often describes a particularly large business (even if it’s a company).
And if we’re talking about a limited liability company, there’s a difference in the owners’ status. Namely, LLC owners are legally referred to as members, while corporation owners are referred to as shareholders.
Forming an LLC is a simpler bureaucratic process than forming a corporation. To register an LLC, you need to choose a name, file articles of the organization, select a registered agent and a managing member. Most importantly, you need an operating agreement.
On the other hand, to become a corporation, you need to hire a transactional attorney, appoint a registered agent and file the articles of incorporation. Also, sometimes, to launch an S corporation, you first need to form an LLC and then fulfil requirements by the IRS.
A profit (more commonly referred to as for-profit) corporation is an organization with a purpose to earn money in the business world. It’s the opposite of a nonprofit organization, which exists for a noble cause.
In other words, whereas a nonprofit is a philanthropic organization, a profit corporation is an institution with clearly defined financial interests.
LLC is a business structure that gives small businesses the largest number of benefits.
Indeed, many small businesses prefer to either form a sole proprietorship or a partnership, due to their straightforward structure and a simpler tax scheme. The problem is that they don’t offer any form of liability protection. On the other hand, starting an LLC allows you to get the legal protection of a corporation, even as a small business.
Forming an LLC is not expensive. Yet, LLC filing costs depend on the state. In some places like Arizona, the set-up price is as low as $50. Meanwhile, in Tennessee, the cost can go between $300 and $3,000.
It’s possible to turn your LLC into a corporation. Still, this doesn’t make the LLC vs corporation an irrelevant comparison. The cost of this conversion, as well as the amount of paperwork that you would have to gather, are far from insignificant. So, you want to ensure that you set up your business properly right from the start.