6 Main Differences Between an LLC and a Corporation
The limited liability company (LLC) and corporation are the two most popular formal business entities in America today. They share many similarities, such as the way they both protect your personal assets in case your business is sued.
However, there are also some key differences between these two entity types, and understanding those differences will help you decide which structure is the right choice for your company. In this brief article, I’ll run down a few of the most important differentiators between the LLC and the corporation.
Startup and Maintenance Requirements
The first major difference is in the formation requirements, as well as ongoing compliance requirements. In short, an LLC is a much simpler entity to form than a corporation. With a corporation, you’ll need to create a board of directors, adopt corporate bylaws, determine the amount and type of stock to sell, and more. On the other hand, forming an LLC is usually as simple as drafting and filing the articles of organization, and designating a registered agent.
There’s also a significant difference when it comes to maintaining your business structure. LLCs typically only need to file an annual report and/or a franchise tax document, whereas the corporation has many more requirements. Corporations need to hold shareholder meetings, keep detailed corporate minute books, file corporate tax returns, and more. It’s far more complex to keep a corporation in good standing than it is to operate a compliant LLC.
Another important aspect to consider is that LLCs and corporations are taxed differently. Corporations are typically categorized as “C corporations,” and this entity faces what’s called double taxation. This means that the income generated by that corporation is actually taxed twice. First, the corporation itself pays taxes on its profits, and then each shareholder pays taxes on their dividends, in effect taxing the same money twice.
The other form of corporate taxation is the “S corporation,” which is a pass-through entity that avoids double taxation. However, the S corporation has many restrictions that disqualify many corporations from electing this form of taxation — the business cannot be owned in part or in whole by another business entity, it must have no more than 100 shareholders, it can only issue one class of stock, etc.
With an LLC, the default method for taxation is similar to that of a general partnership, in that the profits and/or losses are passed through the entity itself (much like in an S corp), and are claimed by each individual owner on his or her personal return. The other option is to opt into corporation-style taxation, following either the C corp or S corp model.
Flexible Management Structure
In the area of management, the corporation is an especially rigid entity. A corporation needs to have a board of directors that oversees big-picture items for the business, along with officers who handle the daily operations. With an LLC, you can basically choose any management structure that works for you, as you don’t need to pay attention to legal requirements like a corporation does.
An LLC can elect to be managed by its members/owners, or it can be managed by a designated manager or managers. The default option is management by the owners, but it’s easy to switch to management by a manager as well. This is part of what makes the LLC such a good option for small and growing businesses — you’re free to alter your management strategy as your company grows and changes.
Distribution of Profits and Losses
An LLC can choose when it wants to distribute profits to its owners, and it can also decide how those profits should be distributed. You can elect to have the profits divided equally, or you can create an uneven split to reflect varying levels of involvement or investment from each owner.
Corporations operate entirely differently in this regard. These entities distribute profits to stockholders in the form of dividends, which must be distributed equally on a dollars-per-share basis. Dividends can technically be paid at any time, but most corporations (especially smaller ones) choose to pay dividends once per year toward the end of the year.
Corporations Can Issue Stock
It is far easier for a corporation to attract investments, thanks to its ability to issue ownership shares in the form of stock. If you operate an LLC, you can bring in additional owners as a way of injecting new investments into your business, but this is far less common than selling shares of stock. In addition, it’s extremely rare for venture capitalists to invest in LLCs, so this area is another big advantage for corporations.
Corporations have been around for centuries, and therefore there is a considerable amount of legal precedent regarding corporations in the courts. There is rarely any surprise regarding how a court will rule in cases involving corporations because there are so many prior cases to draw precedent from. Additionally, the corporation has the same structure in all 50 states, so there’s no variation on a state-to-state basis like there is with an LLC.
The LLC as a business structure has only been recognized in every state since the 1990s. As such, there is still some uncertainty regarding how these entities should be treated by the courts, which is less than ideal. In addition, each state has its own rules and regulations for forming and maintaining LLCs, which can be confusing and complex if your business operates in multiple states.
Overall, there’s no one-size-fits-all answer to the question of whether the LLC or the corporation is the preferable structure for a small business. In general, though, I typically prefer the corporation if you have ambitious expansion plans, because it’s so hard to attract investors to an LLC, and the corporation’s nationwide legal consistency makes it simpler to operate in multiple states.
I tend to prefer the LLC for small local businesses, as well as for companies operated by owners who aren’t particularly wealthy. Using the pass-through taxation method to avoid the C corporation’s double taxation can save you a considerable amount of money if your owners don’t occupy high personal tax brackets.
If you’re still struggling to decide which option is better for you, I would advise consulting a business attorney. A lawyer can help you determine if an LLC or corporation is the right choice for your business.