LLCs and Corporations: What are They?

Corporations and limited liability companies (LLCs) are two legal entity structures available in the U.S.  If you're involved in a startup, these are two of the entity structures you can choose from.  They operate differently and are taxed differently, but both provide protection for your personal assets if the company faces financial difficulty and both can add increased credibility with customers.

Other company entity options include forming as a partnership or a sole proprietorship, but these entities lack many of the benefits provided by LLC’s and corporations, including personal liability protection. To understand which of these entity structures is right for your startup, you need a basic understanding of each, and you need to consider what the future may hold for the business.

What is Incorporation?

Incorporation was the original way for a company to shield its owners from personal liability and is significantly older than the LLC model. The owners of a corporation are its shareholders. There are two main types of corporations: C corporations and S corporations.

C Corporations generally provide the same liability protection as S corporations, but are subject to different taxation rules, including double taxation. Through the double taxation process, the corporation's profits are initially taxed at the company level, and then the shareholders are taxed on any profit distributions or dividends they receive.  C corporations also allow companies to issue shares to raise funds and get investors.

S corporations will not face double taxation, but they must meet certain requirements, and the tax liability will flow directly through to the shareholders.

Since a corporation is a separate legal entity, it is formed by executing and filing state organization forms -- Articles of Incorporation or Certificate of Incorporation.  S Corporations are also limited to 100 owners and owners cannot be “non-resident aliens.”

What is an LLC?

An LLC is a Limited Liability Company.  The owners of an LLC are its members.  LLCs are similar to corporations in that they protect members from certain liabilities, but they are different from corporations in a number of ways.  For example, LLCs offer a much more flexible and informal structure than corporations, and also the members of an LLC can choose how the entity will be taxed.

LLCs have the flexibility to choose to be seen as a disregarded tax entity (i.e., a sole proprietorship or partnership), S corporation, or a C corporation for tax purposes. The default for LLCs is that taxation is passed on to individual members (the company is a disregarded entity for tax purposes).

A LLC is generally formed by filing Articles of Organization in the state of formation.  Executing an Operating Agreement is also usually recommended.

Some Advantages and Disadvantages of Corporations and LLCs


  • Corporation

    • C Corporation: Venture Capital and Dividends. C corporations are the typical choice for startups looking to bring on private equity or venture capital investment or shareholders in the future, since the company can issue different classes of stock (including preferred or common stock), different levels of dividends, and have unlimited shareholders. This flexibility is a reason why most venture capitalists prefer C corporations when offering funding.  Investors also like the idea of dividends if the corporation makes a profit.

    • C Corporation: Accumulated Earnings to Reduce Taxes. C corporations can keep and accumulate earnings from year to year as long as they are within reasonable limits. Shareholders are taxed only on the actual amount received in dividends, so business profits can be held in the corporation (ex: $1,000,000 business profit).  To the extent the shareholders are also employees, they will also be taxed on the salary (ex: $100,000 salary) they take out from the company.

    • C Corporation: Variety of Benefit Plans and Taxes. Some benefits, including retirement plans, stock options, and employee purchase plans, are only available for C Corporations. Shareholder employees of a C corporation do not pay taxes on these benefits.

    • C Corporation: Control Profit Distribution to Shareholders. C Corporations can control the distribution of profit to shareholders based upon different stock classes of stock as well as by retaining accumulated earnings.

    • S Corporation: Advantage for Business Losses. This allows business losses to be passed through to individuals to be used as deductions on their personal income taxes.

    • S Corporation: Self-Employment Taxes. S Corporations may allow individuals to save on self-employment or Social Security/Medicare taxes in addition to reducing non-business income using losses from the business.

    • Income Splitting to Reduce Taxes. The company may reduce taxes by using income splitting to leave money in the company without paying taxes on it or shifting profit around and using lower corporate income tax rates.

    • Limited Liability. Creditors generally cannot collect a shareholder’s personal assets, but can collect a shareholder’s dividends.

    • Few Legal Surprises. Corporations have been around for centuries, so court decisions and case law are well developed with few, if any, legal surprises.

    • Consistency of Formation. Corporation rules are fairly uniform across the country.

  • LLCs

    • Pass-through taxation or single taxation. Profits and losses in LLCs are generally reported on individual tax returns, not at the business level. Business operating losses can be deducted on personal tax returns and can offset other income.

    • Management flexibility. LLCs can choose their own managers, leaders, and owners, as well as elect to have no distinction between an owner and manager of the LLC.

    • Limited Liability. In some states, creditors cannot collect the members’ LLC distributions.

    • Allocation of profits and losses. LLCs can make special allocations of profits and losses among members regardless of the member’s capital contribution to the LLC, but S corporations cannot since S corporations can only have a single class of stock with the dividends distributed as a proportion of the shareholder’s capital contribution.

    • Borrowed money lowers taxes. Money that is borrowed by the company may increase the tax basis and lower the taxes of owners.

    • Property Contributions are not taxable. Depending on how the LLC is set up, property contributions are not taxable, even for minority interest owners.

    • Foreign ownership. Owners of an LLC can be foreign persons, other corporations, or any kind of trust.

    • Less paperwork. LLCs avoid annual meeting and formal record keeping requirements.

    • Reduced Taxes. LLC members are generally not employees, so their profit is not subject to Social Security and Medicare taxes; they would, however, be subject to self-employment tax.


  • Corporations

    • Double Taxation. Corporate profits for C Corporations are taxed twice, when corporations pay tax on the profits and then when shareholders pay individual taxes if the profits are received as dividends (not for S Corporations).

    • Shareholders are separated from the business operations. Shareholders are considered the owners of the corporations, but generally only have the power to elect directors unless they are voting for approval of major corporate decisions. A shareholder can be elected as a director or appointed as an officer.

    • Strict Management Structure. Corporations must have a corporate structure with a board of directors that handles the management responsibilities of increasing shareholder profits and allocating company resources and corporate officers who handle the day-to-day operations.

    • S Corporation: Less Flexible Stock Classes. S corporations generally have only one class of ownership.

    • S Corporation: Profits and Losses Allocated on Percentage Ownership. Since S corporations must have only one class of ownership, profits and losses from the business must be allocated based upon capital contributions from shareholders.

    • S Corporation: No More than 100 Owners. Owners also cannot be “non-resident aliens,” C Corporations, LLCs, other S Corporations, or non-qualified trusts. LLCs and C Corporations do not have limits on the number of owners.

    • S Corporations: Increased Taxes. Sole proprietors, partners, and employees owning more than 2 percent of an S corporation must pay taxes on the benefits such as group-term life insurance, medical reimbursement plans, medical insurance premiums and parking.

    • More Record Keeping. Corporations are required to maintain a ledger that explains how the company reached important decisions as well as keeping voting records for shareholders and directors. Corporations are also required to hold at least one meeting per year which may have to occur in the state where the company was incorporated.

    • No Tax Savings on Operating Losses. C corporation shareholders cannot deduct operating losses.

  • LLCs

    • No Stock for Investors. LLCs cannot issue stock as a way to raise money and cannot have an initial public offering allowing the public to invest in the company.  There are, however, other ways to obtain investment for LLCs, such as issuing new membership interests.

    • Increased Taxes on Business Profits. Members must generally pay taxes on profits even if the profits stay within the company.

    • Increased Personal Taxes. Members must generally also pay self-employment taxes on their income (including salary and share of profits), unless different tax status is elected.

    • Benefits Taxes. Members must generally pay taxes on certain benefits given to employees like health benefits, employer contributions to HSAs or FSAs, and life insurance benefits.

    • May Automatically Dissolve. An LLC may automatically dissolve if a member of the company leaves or sells interest in the business, depending on the language of the Operating Agreement. Corporations instead continue to exist regardless of who the owners are.

    • LLC laws vary. LLCs were created from a combination of the corporate and sole-proprietorship/partnership entity forms and have characteristics of both entities. Since this is a “new” legal entity with varying characteristics, LLC treatment may vary from state to state.

    • Fewer Legal Precedents. LLCs were first recognized in the 1970s, and thus there are fewer case law examples to guide courts.

Frequently Asked Questions

This depends on your business needs. A lawyer can help you decide.

  • How can LLCs raise money without issuing stock?

By taking on partners or investors, adding owners who pay into the LLC, or taking out loans.

  • Can I remain a partnership or sole proprietor?

Yes, but your own assets will be in danger should the company go under or get sued.

If you need help learning more about LLC’s and Corporations, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.