Choosing between an LLC and a corporation can be a tough decision, especially if you don’t fully understand your choices. Every business owner’s situation and goals for their company are different, which means that what works for someone else might not work for you. Instead, if you are considering starting an LLC, you need to have a firm grasp on the differences between these two choices to make a wise decision for your specific situation.
Both an LLC and a corporation are separate business entities. They are distinguishable from a sole proprietorship because there is a clear separation between your personal finances and your company assets and debt obligations. As both an LLC or a corporation, you must register to do business in the state in which you operate for both legal and tax purposes.
Although both types of companies offer some limited liability and asset protection and require filings with the state, that is generally where the similarities end.
What is an LLC?
A limited liability company (LLC) is a type of business that has many of the advantages of both a corporation and a sole proprietorship. They have members rather than stockholders, and they are a favorite of small businesses because they have specific tax advantages, and they are relatively easy to maintain.
What is a Corporation?
Most business owners understand the very basic notion of a corporation. In general, a corporation is defined by the following attributes:
- Ownership via stockholders or shareholders
- Limited liability
- Separate tax rates
- Management and oversight from a board of directors
- Require specific legal filings to maintain the corporation
There are actually two types of corporations: C-corp and S-corp.
What is a C-Corp?
A C-corp is probably the first type of corporation that comes to mind when you think of corporations. These are often large companies, with hundreds, if not thousands, of shareholders. They have a complicated corporate structure with a board of directors that will usually not be the same as the shareholders. When you think of companies that trade on NASDAQ or NYSE, you are thinking of C-corporations.
One of the major drawbacks of a C-corp is that it has its own separate tax treatment. It has a tax rate of 21% as of 2020. Then, individual shareholders are taxed at their individual tax rates as well. Every dollar that comes into a corporation is taxed twice—once at the cooperate level and a second time at the individual shareholder level.
What is an S-Corp?
An S-corporation is different. It is actually much more similar to an LLC instead of a traditional “corporation.” The S-Corporation gets its name from the S subchapter in the Internal Revenue Code. While an S-corp has different tax treatment, it is also different for several other reasons, too.
An S-corp must meet the following requirements.
- It cannot have more than 100 shareholders
- It cannot have any corporations or business entities as shareholders
- It must be organized in the United States
- It can only have one class of stock
- It must meet specific eligibility requirements (such as not being an insurance company or a certain type of financial institution)
The main benefit of having an S-corporation is that it acts as a pass-through entity, just like an LLC would. That means that it avoids some of the negative aspects of a C-corp, such as having a separate tax rate. Avoiding this extra step means that S-corporations are not taxed twice like a C-corp would be.
Choosing Between a Corporation and an LLC
For most small business owners, the choice between a corporation and a limited liability company is actually the choice between registering as an LLC or an S-corp. These legal entities are very similar when viewed in this light. However, there are some key differences that a business owner should consider before forming an LLC or creating a corporation.
Those who own an LLC are known as “members,” while those who own a corporation are called “shareholders.” The difference can be significant in some cases, or it can be very subtle. For example, many LLCs have very stringent restrictions on how members’ rights can be transferred. As a rule, it will be much easier to purchase stock in a corporation compared to selling membership rights in an LLC.
If you have a small business and you want to keep tabs on ownership, having an LLC may be the right approach for you. If you’re going to encourage widespread ownership, a corporation may be your best bet.
Recording Keeping and Management Requirements
The paperwork required to comply with state laws to upkeep your corporation will generally be more demanding compared to an LLC. The management structure in a corporation is also more rigid, such as requiring a board of directors. Shareholders are also required by law to have regular meetings, as well. There are no (or much less demanding) requirements to maintain an LLC.
Small businesses often prefer forming an LLC because the formal legal requirements are far less rigorous. That cuts down on the cost and time that it takes to legally maintain your business.
As discussed above, tax treatment for an LLC and a C-corporation can be very different. However, taxes for an LLC and an S-corp are pretty similar. In general, business owners will attempt to classify themselves as an S-corp, if possible, to avoid the adverse tax treatment of a C-corp, but that isn’t always possible.
LLCs can also choose to be taxed as if they are other entities, such as a partnership or sole proprietorship. A corporation, no matter which type, does not have that same flexibility.
Getting Help with Your Decision
The differences between an LLC and a corporation may not be obvious. As a result, it may be a good idea to talk to a business attorney and/or a tax professional to help you work through which option will work best for you.