Key Takeaways

  • An LLC (Limited Liability Company) is not a corporation, but a distinct business entity that combines the liability protection of a corporation with the tax flexibility of a partnership or sole proprietorship.
  • LLCs provide pass-through taxation, meaning profits and losses flow through to members’ personal tax returns, avoiding corporate-level taxation.
  • Corporations, including C corps and S corps, face stricter management structures, recordkeeping rules, and—depending on type—different tax treatments.
  • The IRS allows LLCs to elect to be taxed as a sole proprietorship, partnership, C corporation, or S corporation.
  • LLCs are especially favored by small businesses and startups seeking operational flexibility and liability protection without complex corporate formalities.

What type of corporation is an LLC? Some entrepreneurs mistake an LLC for a corporation. An LLC is a mixture of corporate and partnership characteristics, as well as its own features. This relatively new business structure was not widely accepted until around the 1990s. This new entity is still not well understood by new business owners. Some mistakenly believe an LLC is a type of corporation. An LLC is its own kind of business entity that combines beneficial features from other business types.

Different Business Types

There are many business types other than the limited liability company (LLC) entity, including the following:

  • Sole Proprietorship. Sole proprietorships have one owner. Unlike an LLC or a corporation, a sole proprietorship is not a separate entity from its owner. The owners report profits and losses on their tax returns. It is pretty simple to start a sole proprietorship since it does not require any state filings. Still, beware that, as a sole proprietor, you are personally liable for company debt and lawsuits.
  • Corporations. A corporation is an entity separate from its owners (known as shareholders). A corporation and its shareholder are both subject to taxes (known as double taxation). However, unlike a sole proprietorship, a corporation shields its shareholders from personal liability.
  • Subchapter S Corporations (S Corporations). A subchapter S corporation (S corp) is a corporation that is not subject to double taxation. You do not register an S corp with the state; instead, you set up a corporation. When you file with the IRS, you elect an S corp status. There are strict time-based guidelines. Check with your local tax office or tax professional for assistance.
  • Limited Liability Companies. A limited liability company (LLC), like a corporation, is formalized through state registration. LLC laws are not as strict as corporate laws. There is flexibility in how they are set up. The IRS does not recognize an LLC as an entity. Therefore, all profit and losses are included in the LLC members' tax returns.
  • Partnerships. Partnerships are like sole proprietorships, except they have more than one owner (called partners). Partnerships do not benefit from liability protection — the partners are cumulatively responsible for business debt and lawsuits.
  • Professional Corporations (PCs). A professional corporation is a corporation for professionals, such as lawyers, doctors, and accountants. However, PCs do not offer their owners limited liability protection.
  • General Partnerships. General partnerships are partners who participate in running the business operations. A general partnership denotes that all the partners are general partners. All partners are responsible for the business debts and liabilities.
  • Limited Partnerships. A limited partnership has both general partners and limited partners. Limited partners do not operate in the day-to-day business operations and are not responsible for business debt and liability as a general partner.
  • Limited Liability Partners (LLPs). Like its name denotes, an LLP is a partnership created with general partners, and like an LLC, the general partners are protected from any business liability as well as any debts from fellow partners.

Business types vary from state to state. Check with your secretary of state office to get a list of legal entity formations.

How an LLC Differs from a Corporation

Although both LLCs and corporations are formed through state registration, they operate under different rules and structures. A limited liability company (LLC) is a flexible legal entity that shields its owners (called members) from personal liability for business debts. In contrast, a corporation is owned by shareholders and governed by a board of directors responsible for making key business decisions.

LLCs are not corporations in a legal sense. Instead, they borrow features from both corporations and partnerships:

  • Like a corporation, an LLC provides limited liability protection, keeping personal assets separate from business debts and lawsuits.
  • Like a partnership or sole proprietorship, an LLC offers pass-through taxation, allowing members to report business income on their personal returns.

Corporations—especially C corporations—face double taxation, meaning profits are taxed at the corporate level and again when distributed as dividends. However, S corporations avoid double taxation by electing pass-through treatment with the IRS. LLCs can make a similar election to be taxed as an S corporation to reduce self-employment taxes.

What Is Incorporation

Incorporation is the term used to describe the process when converting your sole proprietorship or general partnership to its own entity. The two most popular business entities are a corporation or an LLC.

LLC Tax Classification Options

While an LLC goes through an incorporation-like process with the state, it is treated differently by the IRS. The IRS does not recognize LLCs as a distinct tax entity, so the company must choose how it wants to be taxed:

  • Single-member LLCs are treated as disregarded entities, meaning the IRS taxes them like a sole proprietorship.
  • Multi-member LLCs default to partnership taxation, splitting profits and losses among members.
  • LLCs can elect to be taxed as a C corporation (Form 8832) or as an S corporation (Form 2553) if they meet IRS requirements.

This flexibility allows LLC owners to choose the most beneficial structure based on their income, reinvestment plans, and tax strategy. For instance, S corporation taxation can reduce self-employment taxes for active owners, while C corporation taxation may be preferable for businesses that plan to retain profits or attract investors.

When Does an LLC Make a Right Business Type?

LLCs were formed to help small business owners. Corporations have regulatory statutes, like having a board of directors, that many small businesses do not need. The following are some valid reasons to form an LLC:

  • You are starting a business and expect a loss for at least two years.
  • More flexibility in the accounting method you use with an LLC. Corporations do not have such flexibility.
  • The liability protection an LLC offers for companies that own real property.
  • Flexibility in your management structure and business operations.

LLCs go through the incorporation process, but they are not corporations. While they are their own entity, they enjoy liability protection like a corporation. LLCs are not ideal for all businesses. For instance, if you need outside investors, then you may want to evaluate whether a corporation or an S corp is a better fit.

Choosing Between an LLC and a Corporation

When comparing an LLC vs. corporation, the decision often depends on how you plan to grow, fund, and manage your business.

You may prefer a corporation if:

  • You intend to issue stock or raise venture capital.
  • You plan to go public in the future.
  • You want clearly defined corporate governance and a perpetual structure.

You may prefer an LLC if:

  • You value operational simplicity and flexible ownership structures.
  • You want to avoid double taxation and simplify accounting.
  • You are a small business owner or startup not seeking outside investors.

The U.S. Small Business Administration notes that many entrepreneurs start with an LLC for its flexibility and later convert to a corporation if growth or investment goals change.

Advantages and Disadvantages of an LLC

Before deciding what type of corporation an LLC most closely resembles, it’s essential to understand its benefits and limitations:

Advantages:

  • Limited liability: Members’ personal assets are protected from company debts and lawsuits.
  • Pass-through taxation: Income passes through to members, avoiding double taxation.
  • Flexible management: Members can manage the LLC directly or appoint managers.
  • Simplified compliance: LLCs typically have fewer annual reporting and meeting requirements than corporations.
  • Adaptable taxation: The ability to elect C or S corporation status provides flexibility for growth and tax optimization.

Disadvantages:

  • Self-employment taxes: By default, LLC members must pay self-employment taxes on all earnings.
  • Limited investor appeal: Corporations are generally preferred by venture capitalists because they issue stock.
  • State-by-state differences: LLC rules, filing fees, and taxes vary widely depending on state law.
  • Limited lifespan in some states: Certain states require renewal filings or impose dissolution rules if members leave.

Overall, an LLC offers a balance between simplicity and protection, making it suitable for small businesses that want legal safeguards without corporate formalities.

Frequently Asked Questions

1. Is an LLC considered a corporation by the IRS? No. The IRS treats LLCs as pass-through entities by default. However, an LLC may elect to be taxed as a C corporation or S corporation for strategic reasons.

2. What is the main difference between an LLC and a corporation? A corporation has a formal structure with shareholders and directors, while an LLC offers a more flexible structure managed by its members. LLCs also have simpler compliance requirements.

3. Can an LLC become a corporation later? Yes. An LLC can convert to a corporation through a statutory conversion or merger process if the business seeks investors or wants to issue shares.

4. What are the tax benefits of an LLC? LLCs enjoy pass-through taxation, meaning profits and losses are reported on members’ personal tax returns. They can also choose corporate tax status for additional flexibility.

5. Which is better for small businesses—an LLC or corporation? For most small businesses, an LLC provides easier management and liability protection without the formalities of a corporation. However, corporations may be better for businesses planning to raise capital.

If you need help forming an LLC, 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.