Is LLC a Corporation: Everything You Need to Know
“Is LLC a corporation?” is a common question, but there are in fact significant differences between Corporations and Limited Liability Companies (LLCs). 6 min read
Is LLC a Corporation?
“Is LLC a corporation?” is a common question, but there are in fact significant differences between Corporations and Limited Liability Companies (LLCs). There are advantages and disadvantages to both; in some cases a business is better off being incorporated, and in others a business does better as an LLC. Business owners need to understand the differences between the two.
Corporations are owned by shareholders, and are ideal for business that will be owned by many different people or entities. LLCs, on the other hand, are usually preferable when there will be only one owner or a handful of owners.
LLCs are more flexible in how they can be managed, and LLC owners have more freedom to decide how they are run. Moreover, LLC finances do not need to be publicly disclosed as is the case with corporations. There are no public disclosures that an LLC needs to make regarding how an LLC operates.
Corporations have strict reporting requirements and administrative requirements. Corporations are also regulated in terms of how they are managed and run. A Board of Directors, annual meetings, record keeping, and Bylaws are required for corporations; none of these requirements exists for LLCs
Corporations can issue stock. This is an incredibly valuable tool for businesses that want to expand or attract new investors. LLCs cannot issue shares publicly and it is much more difficult to sell investors on buying an ownership interest in an LLC. Lenders are also more likely to lend money directly to a corporation without requiring any kind of personal guarantee from the company owners.
Both corporations and LLCs can only be created by filing the paperwork with the state government. In most states, these filings are made with the Secretary of State. The filing requirements are much more costly and complex for corporations, however.
Legal Entity vs. Tax Entity
Both LLCs and corporations are separate legal entities from the individuals that own them. For this reason, neither shareholders of a corporation nor Members of an LLC are liable for the debts of a company. But traditional corporations are also separate tax entities that are taxed at the corporate tax rate by the IRS. On the other hand, LLCs are not separate tax entities and are not taxed.
By default, LLCs are instead knowns as “pass through” entities, because the profits and losses of the company pass directly through to the Members individually. So instead of the LLC paying taxes on the company’s profits, the Members pay taxes on their own payments from the LLC on their own personal income taxes. However, LLCs have the freedom to choose to be taxed as a corporation if the Members choose to be.
Why is an LLC NOT a Corporation?
Simply put, an LLC is not a corporation because it is not incorporated. There are no shareholders and corporate rules do not apply to LLCs. As mentioned, one of the biggest differences this makes is in the way that corporations and LLCs are taxed.
How are LLCs and Corporations Formed?
Any person or group of people can form an LLC. The owners of an LLC are called “Members,” and the proceeds they earn from the LLC are considered personal income. LLCs can be formed by filing Articles of Organization with the state. Articles of Organization are simple documents that contain the name of the LLC, the names and contact information of the Members, and the name and contact information of the registered agent for the LLC (the person that is to accept legal papers on behalf of the LLC). Some states have additional requirements.
Corporations are formed by filing Articles of Incorporation with the state. As mentioned, there are many more requirements necessary to form a corporation, including the number and type of shares and Bylaws. Corporations also must have a Board of Directors.
How are Corporations and Limited Liability Companies Alike?
The big benefit of both corporations and LLCs are that both are separate legal entities, so the owners of either are not liable for the company’s debts.
Corporate and LLC Owners and Taxes
Corporations must pay taxes on corporate profits at the corporate tax rate. When shareholders receive dividend payments, they must also pay taxes on these payments as individual income. This is referred to double taxation. The S corporation is a type of corporation that avoids double taxation, but is subject to stringent restrictions.
LLCs avoid double taxation because the LLC itself is not taxed. LLC Members are taxed based on their own Adjusted Gross Income for the payments they get from the LLC in the form of a self-employment tax. But as mentioned, LLC Members can choose instead to have the LLC be taxed as a corporation. In some cases, electing to be taxed as a corporation is the best financial move for LLC Members. When corporate owners also work in the business, they pay a tax on their income from the corporation as well as FICA taxes.
Different business structures and different personal incomes of owners mean that either option could be smart. Although being double taxed seems like it would always be a bad thing, the corporate form gives other benefits that sometimes make incorporation worth it. It all depends on the circumstances.
A benefit of LLCs is that they have the freedom to distribute ownership between Members however the Members want. How much capital or labor a person contributed is irrelevant. Corporations, on the other hand, are generally strictly owned in direct proportion to the number of shares a person has.
Traditional C corporations can create unique stock structures, but S corporations cannot. S corporations can only have a single class of stocks, and cannot have more than 100 shareholders.
LLC or Corporation? Who Can Help Make This Decision?
Making a choice of entity for your business is a big decision. There are two types of professionals you should speak with before deciding: a business attorney and a CPA. Both can offer expert advice and insight to help you make the best choice based on your specific business model and financial needs.
A corporation is required to have a Board of Directors. The Board handles the major decisions and implements the broad strategy of the company. The Board elects corporate officers to handle day-to-day management duties. Shareholders of a corporation are the owners, but aside from a few rare circumstances, shareholders are not typically involved in the management of a corporation beyond occasional Board of Directors elections. The same person can be a shareholder, Director, and/or an officer, however.
There are few regulations for how LLCs need to be managed. Members are free to be as involved as they want in the management of the LLC, to create a Board of Directors or not, and to hire or elect whatever officers they choose. This management flexibility is appealing to many small business owners. It also allows LLCs to operate with fewer expenses than corporations.
The legal differences between a corporation and LLC should be fully understood before choosing between the two. While corporations and the rules governing them have been around for centuries, LLCs have only been accepted since the 1970s. Therefore, while the corporate form and the rules governing corporations are well developed, the rules governing LLCs are sometimes less clear.
Another consequence of LLCs being so new is that different states have not yet developed completely uniform rules governing them. Before deciding on an LLC, business owners should understand how their state defines and regulates them.
Advantages of an LLC
LLCs, like corporations, insulate individual owners from personal liability for company debts. And because they are not considered separate tax entities, the problem of double taxation is avoided with an LLC. LLCs are cheaper to set up and maintain than corporations, and management flexibility is much greater.
Disadvantages of an LLC
There are a few disadvantages to the LLC, especially for large or growing business. Because LLCs cannot issue public stock, is more difficult for LLCs to expand or attract investors. Although avoiding double taxation is usually beneficial, in some cases an owner’s tax situation may actually be better if they are shareholders of a corporation as opposed to Members of an LLC. And as mentioned, LLC laws are less uniform from state-to-state, which can create legal uncertainties.
Starting an LLC
The first step to starting an LLC is to choose a name and make sure that the name you want is available. If the name you want for your LLC is already taken, federal trademark laws will prohibit you from using it. After you’ve decided on the right name, you must draft and file Articles of Organization with the state. In most states, this filing is made with the Secretary of State.
Next, you should draft an Operating Agreement. This is a document that establishes how the LLC will be managed, the rights of the members, and plans for contingencies such what happens when a Member leaving the LLC.
In many states and municipalities, LLC owners must also get a state or city business license. The requirements vary from jurisdiction to jurisdiction. LLCs must also attain an Employer Identification Number (EIN) from the IRS.
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