When trying to choose a structure for your small business, a limited liability company (LLC) and a corporation are two common options. An LLC is a legal structure that provides personal liability protections and combines the benefits of a corporation and a partnership. Although a corporation also offers liability protections, it differs from an LLC in terms of ownership structure, management and taxes.
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The word corporation can refer to multiple business structures, including C-corporations, S-corporations and nonprofit corporations. Because C-corps are the default legal entity, however, the general use of “corporation” typically refers to this type of structure.
Understanding these differences will help you decide which business entity type is right for your needs. Here’s what you need to know about LLCs vs. corporations.
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LLC vs. corporation, summarized
LLC | Corporation | |
|---|---|---|
Ownership | Membership interests. Owned by one or many members; no maximum number of members. | Shares. Owned by shareholders; no maximum number of shareholders. |
Management | Managed by members or designated managers. Minimal recordkeeping and annual requirements. | Managed by directors and officers. Stricter initial and ongoing requirements; requires bylaws and issuing stock, as well as annual shareholder meetings and reporting. |
Liability | Limited liability for members and managers. | Limited liability for shareholders, officers and directors. |
Taxes | Owners can choose their desired tax treatment. Can avoid corporate taxes (i.e. double taxation) when treated as a pass-through entity. | Double taxation. Corporation is taxed as a business entity; shareholders receive profits and are taxed at the individual level. |
Differences between an LLC and a corporation
LLCs and corporations are both business entities that are created by filing formation documents with the state. Both structures provide their owners with limited liability protection. In other words, these companies exist as their own legal entities, thereby protecting the owners from being held personally liable in the event of bankruptcy or lawsuits.
Here’s how LLCs and corporations differ:
Ownership
LLCs are owned by members. Each member owns a percentage, also called a membership interest, in the business. You can have a single-member LLC — an LLC with one owner — as well as a multi-member LLC. There is no limit to the number of members you can have, and members may include individuals, corporations, other LLCs and foreign entities (although this may vary by state).
Corporations, on the other hand, are owned by shareholders. Shareholders invest money or assets in the business in exchange for shares of stock that correspond to ownership. There is no limit to the number of shareholders a corporation can have.
Formation
To form an LLC, you must file a legal document called the articles of organization with your Secretary of State. The articles of organization contain basic details about your LLC, including its name, address and information about the members.
Although only required in a handful of states, it’s generally advised that you also create an LLC operating agreement. This document outlines how the LLC will be run, how membership interest is distributed and how it can be transferred between members.
The operating agreement should also specify what happens when a member leaves the LLC. In some states, if this information is not included, the LLC must be dissolved when a member leaves.
To form a corporation, you’ll file articles of incorporation with your Secretary of State. Similar to articles of organization, articles of incorporation contain basic information about your business. After you file with the state, you’ll need to complete a series of tasks that aren’t required for LLCs.
As a corporation, you’ll need to create and adopt corporate bylaws, elect a board of directors and issue stock to shareholders. Unlike LLCs, however, it’s relatively easy to transfer corporate shares — and corporations can survive even if a shareholder leaves the business. For this reason, professional investors prefer to work with corporations.
» MORE: How to incorporate a business
Management and ongoing requirements
Corporations have fairly strict management and ongoing requirements, whereas LLCs have more flexibility.
A corporation’s elected board of directors manages the company as a whole, and appoints officers to run day-to-day operations. Corporations must hold annual shareholder meetings, record stock issues and transfers, file annual reports and maintain corporate records, among other ongoing requirements.
LLCs, on the other hand, can be managed by their members (called a member-managed LLC) — or members can elect managers to run the business. Although most states require LLCs to file annual reports, this is not required in every state — and LLCs don’t typically have many other formal requirements.
Taxes
Perhaps the biggest difference between LLCs and corporations is how they’re taxed. By default, corporations are taxed as C-corporations. The business pays corporate taxes and the shareholders pay personal income taxes on profits they receive from the company. This is often referred to as double taxation.
To avoid double taxation, some corporations elect to be taxed as an S-corporation. With an S-corp, profits pass through to the shareholders’ personal tax returns and they pay taxes on those profits. Not all corporations qualify to be an S-corp, however. S-corps can only have one class of stock and no more than 100 shareholders.
LLCs have more flexibility in choosing how they’d like to be taxed. LLCs do not have their own IRS tax classification. Instead, single-member LLCs are taxed as sole proprietorships and multi-member LLCs are taxed as partnerships by default.
When taxed as a sole proprietorship or partnership, an LLC benefits from pass-through taxation (and avoids double taxation). This means that the profits of the business pass through to the members, and the members pay income and self-employment taxes on their share. An LLC can, however, elect to be taxed as a C-corp or an S-corp.
How to choose between an LLC and a corporation
When selecting an organizational structure for your business, there are many factors to consider.
You might choose an LLC if you want to avoid corporate taxation, don’t plan to fundraise with investors and prefer minimal formal regulations. You might choose a corporation, on the other hand, if you’re looking to sell ownership, attract investors or go public in the future.
It’s often helpful to consult with a certified public accountant or business attorney to get professional advice on what’s best for your needs.
A version of this article originally appeared on Fundera, a subsidiary of NerdWallet.
