LLC vs. Corporation: What’s the difference?

Business owners often face a challenging decision when it comes to forming a legal entity: LLC vs. corporation? While there are some similarities between the two business types, there are many differences which affect areas such as liability and tax options.

An LLC or Limited Liability Company is owned by one or more members and benefits from pass-through taxation. A corporation is owned by its shareholders and is subject to double taxation. If you’re an entrepreneur deciding on the best legal structure for your business, this blog will help you understand the key differences between LLCs and corporations, covering the most important aspects that business owners need to consider.

What’s the difference between an LLC and a corporation?

There are four key areas to look at when it comes to a corporation vs. LLC: liability, ownership, management, and taxation. Understanding the differences (and similarities) that each entity has in these areas will ensure you choose the best business type.

Liability

Many small business owners and sole proprietors opt to form a corporation or LLC due to the limited liability protection they provide. In both instances, LLC owners and corporation shareholders are personally protected from issues such as lawsuits, debt, and bankruptcy.

However, it is important to note that shareholders and owners are not completely immune to personal liability. For example, if they use a company to commit fraud, courts can “pierce the corporate veil”, essentially disregarding the entity’s separate status and holding the individuals directly involved in the wrongdoing, liable for their actions.

Ownership

A major difference between an LLC and a corporation is the ownership structure. Corporations are owned by shareholders, who own shares in the company. These shares of stock can be easily sold and bought, which introduces more investment opportunities.

In contrast, LLC owners (or members) own the business, and their membership interests set out their shares of the company. Unlike stock shares, membership interests are not as easily transferred, and the operating agreement needs to be updated every time a new member joins or leaves.

Management

Corporation and LLC management structures differ slightly. For corporations,shareholders el ect a board of directors who manage company-wide decisions and appoint positions such as the CEO, to oversee daily operations, and usually take more of a back seat in managing the business.

For LLCs, there is more flexibility and opportunities for members to be directly involved in the day-to-day running of the business. Owners can either manage the business themselves (member-managed) or appoint managers (manager-managed) to run the company for them (our blog on LLC member vs manager structure discusses this in more detail).

Taxation

The main difference between an LLC and a corporation is the way in which each is taxed. Corporations are, by default, taxed as C corporations and are subject to "double taxation”. This means corporations pay tax on profits at the corporate tax rate, before paying dividends to shareholders, which are then taxed again.

While shareholders are usually only taxed on profits, a corporation can be elected to be taxed as an S corporation, meaning income is passed through to shareholders directly, eliminating double taxation.

Contrastingly, an LLC’s profits and losses are usually passed through to members, meaning the LLC itself does not pay taxes on income. Instead, owners are taxed at an individual level on any profit they earn.

LLC vs corporation: pros and cons

Business owners may prefer LLCs for their flexible management structures, while others favor corporations for their superior capital-raising opportunities. There are pros and cons to both business types, as outlined below.

Benefits of a corporation

One of the primary benefits of a corporation is the ease of issuing and transferring shares, which facilitates smooth changes in ownership and offers long-term business stability. For example, if a majority shareholder passes away, their shares can be easily transferred to another individual.

Corporations also benefit from rigid and fixed management structures, which can simplify business operations. The well-established hierarchy ensures better organization, enabling individuals to adhere to their assigned duties and fulfill their roles effectively.

Another advantage of operating a corporation is the ability to raise capital easily. Corporations can attract investment through various means, with the most common being the sale of shares for publicly listed corporations or, in the case of early-stage corporations, capital in exchange for equity.

Disadvantages of a corporation

One of the biggest disadvantages of a corporation is the high operating costs. Corporations incur significant expenses, including high corporate taxes, salaries and wages, legal fees, and overhead costs, which can quickly add up.

Another drawback is the strict regulatory requirements. Corporations must adhere to more formalities, such as board of director meetings and annual shareholder meetings. Additionally, their reporting requirements are more extensive compared to LLCs. Corporations are also held to higher compliance standards and must follow strict governance regulations.

Advantages of an LLC

A major advantage of operating an LLC is tax flexibility. LLCs can either choose to be taxed as a corporation or stick to default pass-through taxation which offsets profits and losses to owners, meaning double taxation is avoided.

Another benefit of operating an LLC is management flexibility. Whereas corporations have a more rigid, complex management structure, LLCs can opt to be managed by members or managers. Profits can also be distributed based on the operating agreement, which can be more beneficial to members.

Disadvantages of an LLC

While tax options are flexible, there can be some downsides; LLC members are considered self-employed because profits and losses pass through directly to the owners. As a result, members must pay self-employment taxes, which can sometimes be quite high.

Another drawback is that investors may be hesitant to invest in LLCs since theycannot issu e stock. This limitation can make it challenging for LLCs to raise capital during financially difficult periods.

Corporation vs. LLC: which one should you choose?

There are pros and cons to both corporations and LLCs. When deciding which business type is best for you, consider the following areas and their importance to you:

• Ownership structure: Decide whether you prefer issuing shares, which is typical for corporations, or drafting an ownership agreement, which is common for LLCs. This choice will impact how ownership is defined and transferred within your business.
• Management: If you seek a flexible management structure, an LLC may be suitable. If you prefer a more rigid structure, a corporation might be better.
• Taxation: Corporations and LLCs are taxed differently. Explore the options to determine whether double taxation or pass-through taxation is more advantageous for your business.

FAQs: LLC vs. Corporation