Key Takeaways:

  • LLCs offer pass-through taxation and flexible management but may struggle to attract investors.

  • Corporations can raise capital by issuing shares and have a structured management hierarchy.

  • LLCs are ideal for small businesses, while corporations suit growth-oriented companies.

  • Both structures provide limited liability, protecting personal assets from business debts.

  • Choosing between an LLC and a corporation depends on business goals, scalability needs, and tax strategy.

When it comes to choosing the right business structure, two possible options you might consider are LLCs (Limited Liability Companies) and corporations (Inc.). Both of these business models offer liability protection, but they differ in terms of structure, taxation, and ownership flexibility. In this guide, we will walk you through the main differences between LLCs and corporations, and the pros and cons for both so you can choose the right business structure for you.

What Is an LLC (Limited Liability Company)?

An LLC, or Limited Liability Company, is a flexible business structure that combines elements of a corporation and a partnership. LLCs provide limited liability to their members, protecting personal assets from business debts and liabilities. This means when you form an LLC, your business is treated as a separate legal entity.

Because of this, LLCs are a popular choice for small business owners and entrepreneurs who want to keep their personal assets protected and separate from the business. It’s great for anyone seeking liability protection without the formalities of a corporation.

One of the main benefits of an LLC is pass-through taxation, where profits and losses are reported on individual members’ tax returns, avoiding the double taxation often associated with corporations. In an LLC, any income or loss incurred by the business is “passed through” to the owners or shareholders, which is why it is often called a “pass-through entity”.

Additionally, LLCs offer management flexibility; they can be managed by the members (owners) themselves or by appointed managers. This flexibility makes LLCs adaptable to various business needs, especially for smaller or family-owned businesses.

What Is a Corporation (Inc.)?

A corporation, often referred to as “Inc.,” is a separate legal entity from its shareholders (owners). It has a structured governance system, typically involving a board of directors and appointed officers. Corporations can raise capital by issuing stock, making them attractive for businesses looking to expand or attract investors. Unlike LLCs, corporations must adhere to more formalities, such as holding regular meetings and maintaining detailed records.

Corporations face double taxation, where both the company’s profits and the dividends distributed to shareholders are taxed. However, they can choose an S-Corporation status to gain pass-through taxation and avoid double taxation under specific conditions. 

Despite its formalities and potential tax burden, a corporation is beneficial for businesses that prioritize structured management, ease of transferring ownership, and investor attraction.

Limited Liability Company Benefits

As mentioned above, an LLC has four significant benefits:

  • Limited Liability Protection: LLC members are generally not personally liable for business debts.

  • Pass-Through Taxation: Profits pass through to members’ individual tax returns, avoiding double taxation.

  • Flexible Management: LLCs can be managed by members or managers, providing operational adaptability.

  • Simplified Formation and Fewer Formalities: LLCs have fewer regulatory requirements, making them easy to form and manage.

The LLC's limited liability feature protects members' assets should the business face a lawsuit. If the LLC is sued, the members' assets are protected from seizure to pay off the LLC's debt. Sole proprietorships and partnerships do not protect their owners from personal liability in a suit. 

Furthermore, LLCs benefit from pass-through taxation. Profit and losses pass through the LLC to its members. The members will include the gains and losses on their tax returns. 

Lastly, an LLC management structure is flexible. LLC members can decide whether they will manage the business or appoint a manager. If the LLC is member-managed, then all the members take part in running the day-to-day business operation. With a manager-managed LLC, not all members participate in managing the business operations.

LLC and Inc. Similarities

LLCs and corporations have several things in common:

  • They both must operate in the state they were formed.

  • They are both governed by the state they were formed in.

  • They both offer liability protection to their owners (corporate shareholders and LLC members).

This commonality makes both options appealing to entrepreneurs seeking to protect personal wealth while running a business.

Key Differences Between LLC and Corporation

There are differences between an LLC and a corporation regarding formation, ownership, and taxation. Below are some of the key differences between these two types of business structures:

Formation Process

In the case of an LLC, one or more owners (called members) form an LLC. They file articles of incorporation with the state, in addition to an operating agreement. Although the operating agreement is not required, it is highly recommended to create one as it outlines the management, the ownership, the role that the members play, and other essential business functions. 

On the other hand, a corporate formation is more structured. Along with filing organizational papers with the state, a corporation must designate shareholders, create a board of directors to oversee business management, and have at least one formal meeting each year.

Taxation Differences

LLCs offer pass-through taxation by default, allowing members to report business income on their personal tax returns. This structure avoids double taxation, which can occur when corporate income is taxed at the company level, and dividends are taxed again on shareholders’ returns. LLCs can choose to be taxed as corporations if it benefits their strategy.

Corporations, by default, are subject to double taxation. However, C-corporations can reduce taxable income through business expenses, while S-corporations allow profits and losses to pass through to shareholders' individual returns, similar to an LLC. Choosing between C-Corp and S-Corp status depends on the business’s tax planning needs and growth strategy.

Ownership and Management Structure

LLCs offer a flexible ownership structure. Members own a “membership interest,” and the company can have any number of members. Unlike corporations, LLCs have fewer formal management requirements, which allows for a more relaxed governance approach. This informal structure benefits small or closely held businesses looking to avoid complicated formalities.

Corporations have a structured ownership system based on stock shares, which are easily transferable, allowing the company to raise capital by issuing shares. Corporations must appoint a board of directors and officers, creating a clear hierarchy and separating ownership from management. This structure is advantageous for companies with multiple stakeholders and external investors.

Pros and Cons of LLC vs. Corporation

Now that we understand the differences between LLCs and corporations, let’s look at the pros and cons of both so you can decide which business structure is best for you.

Advantages & Disadvantages of LLCs

LLCs come with unique benefits such as limited liability and protection for personal assets. It also avoids double taxation and offers the choice of corporate taxation if needed. 

In addition to this, forming and managing an LLC is much easier and less complex than forming a corporation. 

However, LLC members may be subject to self-employment taxes on earnings. LLCs are also not allowed to issue stock which can limit their appeal to investors and make it difficult to raise capital.

Advantages & Disadvantages of Corporations

Unlike LLCs, corporations can issue stock, making it easier to raise capital. Furthermore, in the case of a corporation, the business can continue even if ownership changes as the owners are not necessarily the managers of the business.

Corporations also come with properly defined roles that provide a clear, structured hierarchy for managing larger businesses.

However, corporations tend to be more costly and in a sense, come with greater risks. In the case of corporations, profits are taxed at both the company and shareholder levels. In addition, corporations typically have higher costs for formation and ongoing compliance. Corporations also have stricter compliance requirements, such as meetings and records.

Choosing the Right Structure for Your Business

An LLC is an excellent choice for small businesses with few owners or those who value flexibility in management and structure. If you want to avoid the complexity of corporate formalities and double taxation, an LLC may be the right choice. This structure is particularly suitable for freelancers, family-owned businesses, and professionals who require liability protection but don’t need complex capital-raising options.

On the other hand, corporations are ideal for businesses looking to scale or attract investors, as they can issue shares and offer a structured governance model. If your business is growth-oriented and you plan to seek external funding, a corporation may provide the benefits needed to support expansion. Additionally, if your business could benefit from perpetual existence or structured management, the corporate form is likely a better fit.

To make the best and most informed decision, consider talking to a business formation lawyer so you are fully aware of the consequences of choosing one business structure over the other. UpCounsel has tons of informative and helpful resources that you can use to connect with LLC formation lawyers as well as S corp lawyers.

FAQs

Is an LLC or Inc. better for taxes?

LLCs offer pass-through taxation, which can be more tax-efficient for small businesses. Corporations face double taxation but can opt for S-Corp status to reduce tax liability.

What are the main benefits of an LLC over a corporation?

LLCs provide liability protection, flexible management, and tax advantages without the formalities of a corporation.

Can a corporation switch to an LLC or vice versa?

Yes, businesses can change their structure, though it involves a legal process and may have tax implications.