LLC vs Corporation Pros and Cons: Everything You Need to Know
Comparing LLC vs. corporation pros and cons? Limited liability companies (LLCs) and corporations are the two most popular business structures available.3 min read
Updated November 9, 2020:
- Enter into its own contracts.
- File its own taxes.
- Have its own bank account.
- Be essentially distinct from its owners.
A business entity can do many things a person can do. However, a corporation can protect its shareholders from business-related liabilities. An LLC also offers corporate-style liability protections.
What Is a Limited Liability Company?
An LLC is a type of business that combines characteristics of a partnership and a corporation. LLC owners, who are referred to as "members," are not personally liable for business obligations and debts.
Unlike a corporation, an LLC isn't taxed directly. Instead, profits and losses pass through the company to the members, who then report the finances on their personal tax returns. As such, LLCs are perfect for small-business owners who need liability protections but don't need to raise much capital from investors. LLCs are so popular, in fact, that most small businesses started in the last decade have been LLCs.
Forming an LLC is easier than forming a corporation, although you may need to pay the same amount in filing fees. File an articles of organization within your state, and if required, publish a notice of the business's formation in your local paper.
Although it isn't required, you should also consider creating an operating agreement for your LLC, which details member's rights and interest percentages. Also, be sure to obtain the necessary permits and licenses required to conduct business in your area.
An LLC's advantages include:
- Personal liability protection
- Less recordkeeping than corporations
- Easily divided responsibilities and profits
- Easy setup
- Being inexpensive to establish
- Fewer restrictions than corporations
- Flexible organizational structure.
An LLC's drawbacks include:
- Ongoing formation costs
- Less legal precedent
- Inability to raise venture capital
- More difficulty in transferring ownership than in corporations
- Income is subject to self-employment taxes.
What Is a Corporation?
A C corp is a company that shareholders own. The company itself is liable for legal and financial issues. The company is directly taxed on profits, and shareholders are taxed on dividends, resulting in "double taxation."
A C corp structure is a good choice for startups with long-term goals of going public or for businesses requiring ample investment capital.
Most states require the following steps to form a C corporation:
- File an articles of incorporation.
- Establish bylaws and resolutions detailing the company's operating rules.
- Appoint a board of directors.
- Appoint a registered agent.
- Issue stock to the initial shareholders.
The main advantage of having a C corp is the personal liability protection. A corporation is also considered an established business entity, which looks more attractive to investors.
The downside is that corporations:
- Are expensive to establish.
- Require extensive paperwork.
- Are subject to double taxation.
An S corp is not an official business entity. Rather the term refers to the way in which the business chooses to be taxed. The IRS classifies an S corp under subchapter S of the Internal Revenue Code.
The biggest advantage of electing S corp status is that S corps are taxed like partnerships, so they aren't taxed twice. Instead of the company itself being taxed, income passes through the business to the shareholders. The shareholders then report their income on personal tax returns, and the income is then taxed at the shareholder's rate.
Unlike C corporations, an S corporation cannot have foreign investors and is limited to no more than 100 shareholders. Forming an S corp is also similar to forming a C corp.
S corp advantages include:
- Personal liability protection.
- Pass-through taxation.
- Tax benefits for excess profits.
- Cash accounting method.
- Enhanced credibility.
- Perpetual operation even if an owner dies or leaves the company.
- The company pays employees' salaries while deducting payroll expenses.
- Remaining profits after paying reasonable salaries, which are dispersed to owners as dividends.
There are also some drawbacks:
- S corps are subject to closer IRS scrutiny.
- Stock ownership restrictions.
- Less flexible ownership structure.
- Expensive to form.
- Shareholders must adhere to all requirements.
- Additional state taxes may apply.
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