LLC vs. Corporation
Should you form an LLC or incorporate your new business? Are LLCs and corporations really that different? They share some similarities, but the differences between LLCs and corporations can have a major effect on your taxes, protections, ownership, management and more. Below, we go over the similarities and differences between LLCs and corporations.
LLC and Corporation Similarities
- Formation: Both LLCs and corporations are business entities. Both are created by filing paperwork with the state. This is different from businesses like general partnerships or sole proprietorships, which don’t require state filings to form. In most states, LLCs file “articles of organization” and corporations file “articles of incorporation” with the Secretary of State Office.
- Limited liability: Both LLCs and corporations provide limited liability. This means the business and all its liabilities are considered to be legally separate from its owners. Any business debts or assets belong to the business. In other words, if the business gets sued, the owners’ personal assets are typically protected. This is much different from a general partnership or sole proprietorship, where there’s no legal separation between the business and its owners.
- Registered agent requirements: Both LLCs and corporations are required to maintain a registered agent in each state where they do business. The registered agent is the person or entity assigned to receive legal notifications on behalf of the business.
- State compliance: LLCs and corporations must maintain state compliance, typically by filing annual reports. These reports confirm or update basic business and contact information, and most come with a filing fee. While some states have different fees or requirements for LLCs and corporations (for instance, New Mexico and Arizona don’t require reports from LLCs), most states require regular reporting from both entity types.
Differences Between LLCs and Corporations
To decide between forming an LLC or incorporating, it’s important to understand the differences between LLCs and corporations.
Tax election options
LLCs have more tax election options than corporations. Corporations are taxed as C-corps by default. However, they can also opt to file paperwork with the IRS to be taxed as an S-corp if they qualify. Single-member LLCs are taxed as sole proprietorships, and multi-member LLCs are taxed as partnerships by default. However, LLCs can choose to be taxed as either a C-corp or an S-corp as well.
- Partnership or sole proprietorship: These tax designations receive pass-through taxation. This means the business itself doesn’t pay entity-level taxes. Instead, the income “passes through” the business to the owners, who report the income on their personal return. All of this income is subject to self-employment taxes.
- C-corp: A C-corporation files corporate income taxes. Shareholders also have to report any income they receive on their personal tax returns. This is known as “double taxation” since income is taxed twice (once at the entity level and once at the personal level).
- S-corp: S-corps are “small business corporations” and are subject to many restrictions. S-corps are limited to 100 shareholders and 1 class of stock. Shareholders must be US citizens or permanent residents and can’t be corporations, LLCs, or most other businesses. Shareholders can receive dividends, but shareholders who provide services must first be paid a reasonable salary, which is subject to self-employment taxes. S-corps receive pass-through taxation and don’t file a corporate income tax.
Again, LLCs can have any of the tax options above while corporations can only be taxed as C or S-corps. For a quick, easy-to-read summary of the effects of these elections, see our page on How to File LLC Taxes.
LLC owners are called members. Each member owns a percentage of the company, known as “membership interest.” Membership interest is not easily transferable. While the operating agreement or state statutes will outline specific requirements, you’ll typically need the approval of other members before transferring interest—if you can transfer at all.
The owners of a corporation are called shareholders. Shareholders own shares of corporate stock. Stock is easily transferable, which can be more attractive to potential investors.
Company management structure
In a corporation, shareholders elect a board of directors to govern the business. The board elects corporate officers (such as the president, treasurer and secretary) to run the day-to-day business of the corporation and carry out the decisions of the board.
LLC management is much more flexible. In a member-managed LLC, members run the day-to-day operations directly themselves. In a manager-managed LLC, members appoint or hire one or more managers to run the show. In this case, members function more like shareholders, able to vote out managers but not make business decisions.
Charging order protections
Charging order protections in many states better protect an LLC from its members and their personal liabilities. In a corporation, if a shareholder is personally sued, creditors in nearly all states can be awarded the shareholder’s ownership interest in the corporation. This means creditors could potentially take control of a corporation if awarded the shares of a majority owner.
However, if an owner of a multi-member LLC is personally sued, creditors are typically limited to a charging order. A charging order is a lien against distributions—in other words, creditors can collect any profits the owner would have received from the business, but creditors don’t get ownership interest or control of the LLC. Note that the strength of protection varies greatly by state—California and Minnesota, for instance offer fewer protections, while Wyoming extends protections to single-member LLCs.
Corporations typically have stricter requirements regarding meetings and recordkeeping. For example, state statutes nearly always require corporations to hold annual meetings and keep formal meeting minutes, which must be kept in a corporate book. While these are good practices for LLCs to keep as well, state statutes don’t typically require LLCs to maintain these corporate formalities.
It’s also important to note there are other, less tangible differences between LLCs and corporations. The “Inc.” or “Corp.” at the end of a business grants a degree of prestige and authority that “LLC” may not. Corporations have also been around much longer, which gives them years of legal precedence—making it easier to anticipate how legal changes and cases will play out in the courtroom.
LLC or Corporation?
In the end, which one is better: LLC or corporation? The kind of business entity you choose depends largely on the vision you have for your business. Small businesses that value flexibility often opt for LLCs. Large businesses that need more structure or that are seeking many investors may prefer a corporation. Either way, we can help. At Northwest, we form LLCs and corporations, provide registered agent service and much more.START YOUR BUSINESS TODAY!