LLC vs. corporation: What to factor into your choice
Selecting a business structure isn’t just a formality. Your choice will have a long-term effect on your operations, taxes, legal liability, and ability to secure funds from investors and lenders. It’s worth the time to study up, especially if you’re deciding between a limited liability company (LLC) and a corporation.
Consider this article your LLC vs. corporation cheatsheet. We’ll cover the major similarities and differences—from formation to tax time—so you can make the best decision for your small business or startup.
LLC vs. corporation: Similarities
Both of these business structures share qualities that make them a step up from a basic sole proprietorship or general partnership. Here are the main similarities between LLCs and corporations:
Registered business entity
In the United States, the default business type is a sole proprietorship if there’s one owner, or a partnership if there are two or more owners. You don’t have to file any special paperwork with the state or federal government to operate as one of these business entities. That said, these types of businesses still need the proper business licenses and permits to operate.
The process to form an LLC looks very different from that of a corporation. To form an LLC, you’ll create and send articles of organization to your Secretary of State office or equivalent state agency.
To form a corporation, you’ll follow similar steps, but with articles of incorporation instead. Corporations are more complex and have some additional requirements. You’ll also need to create corporate bylaws, elect a board of directors, issues shares of stock, and more. We recommend reading our guide to starting a corporation for the full rundown.
In both cases, your articles will outline your registered business name, address, owner information, mission, duration (how long you’ll do business), and other state-required details. Once you receive state approval, you’re officially an LLC or corporation.
Limited liability protection
Corporations and LLCs protect the personal assets of their owners. When registered properly, they are both considered legal entities that are separate from their owners. As a result, you aren’t personally responsible for the business’s debts or liabilities. This is what’s referred to as limited liability protection or personal liability protection, and it’s one of the biggest benefits of LLCs and corporations.
Put another way, personal assets like your home or car aren’t in jeopardy if the business is sued or shuts down. Creditors, lenders, and other actors can only use business assets, like equipment or property, to cover what’s owed. However, as the name implies, there is a limit to your protection. A court can “pierce the corporate veil” and go after your personal assets in certain cases, so be aware.
For example, let’s imagine a worst-case scenario where your business fails. Creditors may argue that your business never had adequate startup capital to cover its costs and expenses in the first place. So, they’ll argue, you and your business were never truly separate and you should be held personally liable for business debts.
To maintain protections, familiarize yourself with business requirements, regulations, and best practices for whichever entity you choose.
LLC vs. corporation: Differences
Beyond limited liability protection, LLCs and corporations are very different business entities. Your business plan, financial needs, and recordkeeping resources will help you determine which option makes the most sense. Here are the three areas where LLCs and corporations diverge the most:
Ownership and funding opportunities
As an entity type, an LLC is one of the simplest options. The owners of an LLC are known as “members” and can be individuals, corporations, foreign entities, or even other LLCs. Each member owns a percentage of the business, called their “membership interest.”
LLCs can have an unlimited number of members, so you can form a single-member LLC or a multi-member LLC. Members can directly manage operations or appoint someone outside the business. You can add partners and distribute profits as you like, so long as your partners sign off in your LLC’s operating agreement.
Corporations have a strict, standardized management structure, but ownership is more flexible. The owners of a corporation are known as “shareholders” because they’re issued shares of stock. They can be individuals or other businesses, domestic or foreign.
Generally, corporations must elect a board of directors which appoints officers, makes business decisions, and authorizes stock. It’s uncommon for shareholders to manage day-to-day operations, but they can.
If you plan to go public or accept investor funding, a corporation may be the better choice. Anyone can own stock and invest capital, and it’s easier to transfer corporate shares than LLC membership interests. In addition, the corporate split between management and ownership is highly attractive to passive investors. If you’re aiming for rapid growth or a quick exit, an LLC could limit your strategy.
One of the main differences between LLCs and corporations is how business income tax is handled.
With an LLC, you’re able to choose the tax status of other business structures. If you choose to be taxed as a sole proprietor or partnership, you’ll receive pass-through taxation. This means that all corporate profits and losses pass through to your individual tax return. If each LLC member’s personal tax rate is lower than the corporate tax rate, pass-through taxation can save businesses a significant amount of money.
By contrast, most corporations experience double taxation. If you own a C corporation, the most common type, you’ll have to file both a corporate tax return and a personal tax return. Your corporate profits are taxed twice: once when your business claims income, and again when you claim income on your personal income tax return.
One way a C corporation can mitigate its tax burden is to elect S corporation status. S corps enjoy pass-through taxation, but there are several strings attached. For instance, S corps have a limit of 100 owners and can only issue one class of stock. These are just a few examples, so review a full list of S corp qualifications before you start making any plans.
Recordkeeping and reporting
Although paperwork and reporting may not seem like a make-or-break factor, it’s an important consideration. Corporations have to keep up with far more federal and state requirements than LLCs. And overlooking these corporate formalities can have serious legal and strategic consequences for your business.
Corporations must file annual reports, which usually include a number of detailed financial statements, a corporate summary and analysis, operating highlights, notes, and other information. In addition, you have to use formal meeting minutes to document decisions or actions during director and shareholder meetings. These records, along with other corporate files, must be maintained in a corporate record book.
LLCs, on the other hand, have fewer formal recordkeeping regulations. Generally, LLC owners just need to maintain their formation articles, ownership information, licenses, and relevant tax documents. Some states may require annual reports, but it's less common.
LLC vs. corporation: The bottom line
As you can see, both LLCs and corporations bring something different to the table. If your business strategy puts investor funding at the center, organizing as a corporation may be best. On the other hand, if your business would benefit from pass-through taxation — and S corp requirements are out of reach — LLCs may have the edge.
Either way, you’ll receive personal liability protection that lets you take on business challenges and invest in key opportunities without putting your personal assets at risk.