LLCs vs. Corporations: What to Factor Into Your Choice
At a certain point in your journey as a small business owner, you may want to transition from operating your business as a sole proprietor to forming a separate legal entity for your company.
Even if you don’t plan on forming a separate legal entity in the near term, it’s good to have an understanding of your options, since the business entity you choose can have a long-term benefit on your operations, the amount you’re taxed, your legal liability, and your ability to secure funds from investors.
While there’s a few different business entity options to choose from in the US, in this post we’ll focus on the two main types of business structures— Limited Liability Companies (LLCs) and Corporations (also known as ‘C-Corps’), as well as their differences and similarities.
Both LLCs & Corporations Offer Limited Liability Protection
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, and they offer few if any liability protections for their owners.
By contrast, corporations and LLCs protect the personal assets of their owners. That’s because they’re considered separate legal entities.
After you form a Limited Liability Company or Corporation, you’re personally protected from your business’ debts or liabilities. This is what’s referred to as ‘limited liability protection’ or personal liability protection, and it means that 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.
Differences Between LLCs & Corporations
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’s a look at the three areas where LLCs and corporations differ most:
1. Their Structure
How LLCs are Structured
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, otherwise known as an LLP (Limited Liability Partnership). Members can directly manage operations or appoint someone outside the business. You can also add partners and distribute profits as you like, as long as your partners sign off in your LLC’s operating agreement.
How Corporations are Structured
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 have to elect a Board of Directors which appoints officers, makes business decisions, and authorizes stock. Shareholders also usually don’t manage day-to-day operations, but they can.
2. Their Ability to Attract Funding
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.
3. Their Taxation
One of the main differences between LLCs and corporations is how they’re taxed on business income, and their tax benefits.
How LLCs Are Taxed
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.
How Corporations Are Taxed
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.
4. Their Recordkeeping and Reporting Requirements
In general, corporations have to keep up with far more federal and state requirements than LLCs when it comes to recordkeeping and reporting.
For example, corporations have to 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, corporations are required 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.
5. How They’re Formed
The process of forming an LLC is different from the process of forming 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.
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.