Choosing an entity type for when you start a business has far-reaching implications on how you run, grow, and pay taxes as an entrepreneur. Two of the most common types are a limited liability company (LLC) and a corporation.
They may seem similar at first glance, but in reality, they’re designed very differently. The big difference between an LLC and a corporation is that an LLC has one or more owners, while a corporation is owned by shareholders.
Explore how each business classification works and how to determine which is best for your business.
What is an LLC?
A limited liability company is a business structure that offers some tax benefits and personal liability protection. An LLC can have one or more owners (called “members”). Both sole proprietors and business partners can form an LLC to protect their personal assets.
Additionally, LLCs avoid double taxation because they don’t have to pay corporate taxes. They are a pass-through entity, which means the owner passes profits to themself and reports them on their personal tax return.
What is a corporation?
A corporation is a business entity that is owned by shareholders, but which is entirely separate from its owners. As a legal entity, a corporation can employ people, enter into agreements with other companies, and borrow money. There are a few important elements that distinguish a corporation:
S corps and C corps are different types of corporations. They’re also corporate tax designations. A corporation is by default classified as a C corp for tax purposes.
LLC vs. corporation: the key differences
LLCs and corporations have some basic similarities—they’re both legal entities that afford their owners liability protection, for example. But they have far more differences, especially in how they’re taxed and what options they have for fundraising by selling ownership of the company.
Both LLCs and corporations separate the company from its individual owners, offering personal liability protection. Unless someone signs a personal guarantee, creditors cannot come after personal assets for LLC or corporation owners.
The formation process is more complex and expensive with a corporation, including having to elect a board of directors. Corporations file Articles of Incorporation with the Secretary of State for formation, then hold a meet to create corporate bylaws. Once formed, a corporation must hold annual shareholder meetings and record the minutes of those meetings for tax and legal records.
An LLC files Articles of Organization, which requires less information. The internal management is typically outlined in the LLC’s operating agreement, which can be customized to the specific needs and desires of the owners.
LLCs offer a more flexible management structure, allowing the owners, or members, to manage the company directly or appoint managers to run the business. There are generally no strict requirements for board meetings, annual reports, or record keeping.
Corporations have a more rigid and formalized management structure, with distinct roles for shareholders, directors, and officers. Corporations must have a board of directors, elected by shareholders, responsible for overseeing the major decisions of the company. The board of directors appoints officers, such as the CEO and CFO, to manage the day-to-day operations of the corporation.
A corporation has more options when it comes to outside investments. It can raise capital from investors by offering company shares, but LLCs cannot.
Rather, they have members/owners who are allocated a percentage of the company according to the LLC’s operating agreement.
Corporations can be privately owned or be a public company listed on a stock exchange, in which case the company is regulated by the US Securities and Exchange Commission.
An LLC, on the other hand, can’t offer shares; investors would need to be added to the LLC’s Articles of Organization as members/owners in order to receive equity for their investment. In the same vein, a corporation can go public, while an LLC cannot.
LLC members are considered self-employed by the IRS, so they do have to pay self-employment taxes. LLCs can opt to be taxed as an S corporation to lower some of the tax liability for the owner (who would be an employee who receives a W2 form from the company). Payroll taxes apply to their salary, but profit distributions aren’t subject to self-employment tax. Although it can be taxed as an S corp, an LLC is not considered a corporation.
Corporations are taxed by default as C corporations, which are subject to a corporate tax on profits. Corporations with fewer than 100 shareholders (all of whom must be US citizens or permanent residents) may elect to be taxed as an S corp rather than a C corp. S corps enjoy pass-through taxation. LLCs may also elect to be taxed as an S corp, or as a sole proprietorship or partnership (depending on the number of members it has).
As a separate legal entity, corporations are responsible for paying taxes on the corporate level. The federal corporate income tax rate was 21% in 2022. LLCs do not pay this tax; rather, the company profits get passed to the owner and they pay personal income tax.
Advantages of an LLC
Business owners may benefit from a range of advantages as an LLC, including:
- Personal liability protection. Unlike a sole proprietorship or general partnership, an LLC protects the owner’s/owners’ personal assets from lawsuits and creditors. The exception is if the business engaged in fraudulent activities or if the owner signed a personal guarantee on their business financing.
- Multiple tax options. An LLC can elect to pay taxes as a sole proprietorship, a partnership, or an S corp. One may be better than the others depending on how the business operates.
- Easy formation process. Forming an LLC is a simple process compared to other types of business entities, like an S corp or C corp. The required paperwork is minimal, it usually takes around two weeks for the state to process your application, and fees are typically less than $1,000.
Advantages of a corporation
Forming as a corporation comes with advantages for some types of businesses:
- Some taxation flexibility. A corporation is taxed as a C corp by default. Profits are taxed at the corporate tax rate, then investors are taxed on their dividends as well. Both income tax and self-employment taxes apply to these dividends. However, if it meets eligibility requirements, the corporation can elect to be taxed as an S corp to avoid the corporate tax burden.
- Options to issue stock and attract investors. A corporation issues shares to its owners and can offer two types of stock: common and preferred. A corporation taxed as a C corp may issue both types of stock to attract different levels of investors, while an S corporation must choose one. S corps may also cap their total number of shareholders at 100, and all must be citizens or permanent residents of the United States.
Choosing between an LLC or corporation
The choice between an LLC or a corporate business structure is a deeply individualized one. It comes down to how you want to manage your company, pay taxes, and use external investment to grow. You might consider these questions when making the decision:
- What is more important to you: ease of formation or potential to attract investors?
- Are you able to take on the operational complexity that comes with a corporation?
- How will you fund your company—through your own capital investments or through selling ownership?
LLC vs corporation FAQ
Is it better to form as a corp or an LLC?
The best choice for your business will depend on a variety of factors, including the size and structure of your business and the tax and liability benefits that you are seeking. Generally speaking, LLCs provide more flexibility and liability protection than corporations, but corporations may offer more tax benefits. It is best to speak with an attorney or accountant to determine the best option for your business.
Why would you choose an LLC over a corporation?
An LLC is a popular choice for small businesses because of the flexibility and simplicity of its structure. LLCs are typically easier and less expensive to form than corporations and provide owners with more flexibility in how they manage their businesses. LLCs also offer owners the ability to pass through their business profits or losses to their personal tax returns, which can be beneficial for tax purposes. Furthermore, LLCs do not have the same complex governance and reporting requirements as corporations, which can make them easier to manage.
Is it better to be a C Corp or an LLC?
The answer to this question depends on your business goals and needs. An LLC provides personal liability protection and pass-through taxation, and can be beneficial for businesses that are not seeking outside investors. A C corp provides more flexibility in ownership structure, and is often the better choice for businesses seeking outside investment or planning to go public. Ultimately, the best entity type for your business will depend on your specific circumstances.