Corporation vs LLC: Everything You Need to Know
Corporation vs LLC are separate legal entities from the individuals that own and manage them. 5 min read
Corporation vs LLC
Corporation vs LLC are separate legal entities from the individuals that own and manage them. The owners of corporations (shareholders) and LLCs (Members) are both protected from individual liability for the debts and liabilities of the company. Corporations and LLCs can only be created by filing appropriate paperwork with the state. The filing requirements are more stringent for corporations.
Traditional C corporations pay taxes; however, LLCs and S corporations both typically act as “pass-through” entities wherein the profits, losses, and tax burden pass directly to the owners. S corporations always need to file a business tax return. LLCs file a business tax return whenever they have more than one Member. However, no income taxes need to be paid by pass-through entities.
LLCs and S Corps are both pass-through tax entities by default. S corps always must file a business tax return. LLCs do not need to file a business tax return if there is only one Member.
Differences in Ownership and Formalities
Corporations are owned by shareholders, LLCs are owned by Members. There are many more restrictions imposed on the ownership of corporations. An LLC can distribute ownership to members in any way the Members would like. Corporations are generally required to distribute ownership strictly based upon the percentage of stock owned (although, unique class structures can be created in a C corporation).
S corporations are limited to no more than 100 shareholders, and can only be owned by individual United States citizens or resident aliens. S corporations must also have a single class of stocks. LLCs can be owned by any legal entity.
There are a number of formalities that corporations must adhere to, including holding annual meetings, maintaining a Board of Directors, adopting bylaws, issuing stock, and keeping records. LLCs have few administrative requirements.
Differences in Management
LLCs are very flexible in how they can be managed. Members can choose to manage an LLC themselves, appoint others to manage the LLC for them, or structure any combination thereof. Corporations, on the other hand, typically have a strict distinction between the owners and the management. In a corporation, a Board of Directors that oversees the major decisions of the company is typically required, and a team of executive officers usually handles the day-to-day operations.
Corporations exist perpetually by default, but in some states, LLCs are required to have dissolution dates. When a Member leaves an LLC, in some cases, it can cause the LLC to dissolve.
It is much easier to transfer ownership of a corporation as compared to an LLC. Selling and transferring stock is easy; selling membership of an LLC is governed by the Operating Agreement, but can be difficult or impossible sometimes. In an S corporation, shareholders that work at a company can be treated as employees and pay employment taxes.
LLC vs. Corporation: Other Key Differences
S corporation owners are permitted to deduct business losses on their personal income tax returns. S corporations can thus save owners money on taxes compared to C corporations, which are taxed as a separate entity.
LLCs and C corporations can have an unlimited number of owners; S corporations are limited to 100 shareholders. Because it is so easy to sell and transfer stock, C corporations are the preferred choice of many growing businesses. C corporations also offer the ability of different stock classes (i.e., preferred and common stock), which allow for more investment opportunities.
C corporations can carry profits and losses over to the next year to help with the tax burden. LLCs and S corporations typically do not have this option.
Corporations vs. LLC's - Tax Differences
C corporations are taxed as separate entities. Shareholders are also taxed individually when they receive dividend payments. This is why C corporations are said to face “double taxation.”
LLCs and S corporations are also legally separate entities, but they are not taxed. Instead, the tax burden “passes through” to the owners who pay taxes on company profits individually.
Corporate and LLC Owners and Taxes
When corporate shareholders receive dividends, those dividend payments are considered personal income and they must pay taxes on them. LLC members, meanwhile, receive company profits directly in the form of income and must pay taxes on that income.
Legal Entity vs Tax Entity
A legal entity has independent legal rights, but being a legal entity does not necessarily make a company a tax entity. Whether something is a tax entity is determined by IRS and state tax agency classifications. C corporations are a separate tax entity and are taxed by the IRS. S corporations and LLCs are typically not separate tax entities. Profits from S corporations and LLCs are paid by the individual owners.
Corporations have been around for centuries, but LLCs have only been accepted since the 1970s. Today, every state accepts LLCs. Corporations have distinct features and requirements from LLCs. The most important legal distinction is that LLCs are not incorporated, and thus the formal requirements involved with issuing stock and having a Board of Directors do not apply to LLCs.
Corporations suffer from double taxation. Corporate profits are taxed, and shareholders pay taxes on dividends they receive. S corporations and LLCs are not double taxed; only the individuals pay taxes on company profits.
A Third Possibility - An LLC Taxed as a Corporation
It is possible to elect to have an LLC be taxed as a C corporation. For some LLC owners, paying a lower corporate tax rate on profits and then paying taxes again individually for income payments is better than paying all of the taxes according to the owners’ individual Adjusted Gross Incomes.
What is Incorporation?
Incorporating a business means that your business is formally recognized by the state as a corporation. Certain rights, as well as responsibilities, attach when a business is incorporated. When a business is incorporated, ownership is transferred to shareholders, management is vested in a Board of Directors, and state administrative requirements must be adhered to.
How are LLCs and Corporations Formed?
One of more people can form an LLC or corporation by filing paperwork with the Secretary of State of the state where the business will be headquartered. Corporations must file Articles of Incorporation; LLCs must file Articles of Organization. Corporations require Bylaws and a Board of Directors; LLCs require an Operating Agreement. When a corporation is formed,
Limited Liability Company Benefits
LLCs are very flexible in how they can be managed. Unlike corporations, which have stringent management and administrative requirements, LLC Members can choose to operate and manage an LLC almost however they want.
Why is an LLC NOT a Corporation?
An LLC is a “Limited Liability Company.” It is not a corporation as an LLC is not incorporated.
Is an LLC Right for You?
Small business owners and entrepreneurs often find that LLCs are the best choice because they can be managed much more flexibly, are cheaper to establish and maintain, and are better for tax purposes because they are not double taxed.
Is a Corporation Right for You?
While LLCs work great when there are only a few owners of a business, when there are many investors that all want a say in what happens, corporations can provide a better management structure. Corporations are also better for growing businesses that are seeking new investors because they can offer stock. Finally, corporations can provide a number of excellent benefits for shareholders that are also employees.
Is an S Corporation Right for You?
S corporations are not taxed, and instead, owners pay self-employment taxes for their compensation.
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