Choosing the right legal structure for a business should most definitely come early on in the life of your business. For many entrepreneurs, however, Limited Liability Company (LLC) and Corporation are the two options that attract them.
Both corporations and LLCs offer protection from liability and other tax advantages but their management structure, taxation, as well as the level of regulation varies. The owner must know the key differences between being an LLC and a Corporation to achieve the right business strategy.
We’ll examine this in greater detail later as well as the relevant advantages and disadvantages of both structures so that you can ascertain which structure would be more appropriate for your business and future growth ambitions.
Understanding the Basics: What is an LLC?
LLC means Limited Liability Company ensuring that all members of the company receive protection against liabilities along with operational control. In this way, personal assets in most instances cannot be targeted as liabilities to utilize when owing the company’s debts.
One other advantage that the members have, is called pass-through taxation for LLCs. This relieves the Company from paying taxes since any profits or losses will be directed to the personal taxes of the members. The way they operate is less complicated than that of a corporation, making them popular among small enterprises and self-employed people.
To start an LLC, first, you will need to select a business name and file articles of organization with the state along with an application for an EIN with the IRS. LLCs protect against liabilities and allow business flexibility, However, the members are likely to incur self-employment taxes, and some states impose additional costs or requirements.
What is a Corporation? Essential Features
A corporation is a form of an organization registered under law that has a different legal form from its proprietors called shareholders. Such separation provides the proprietors with protection from liabilities meaning that the owners are not personally accountable for all the debts and legal obligations that the company has, only their investments made in the corporation can be lost.
Corporations have a formal structure comprising shareholders, a board of directors, and officers. A corporation is owned by its shareholders, decisions are overseen by the board, and ordinary activities are carried out by officers of the corporation. This structure allows corporations to endure operations regardless of the transfer of shareholders thus giving the corporations “perpetual existence”.
Here are its key features:
Limited Liability: Shareholders of a corporation do not normally, therefore, have to pay the company’s debts or deal with legal problems that preserve or protect their possessions and wealth.
Ownership Structure: Corporations are owned by shareholders and managed by a board of directors, with officers handling day-to-day operations.
Perpetual Existence: A company has a life altogether ignoring the change of ownership or shareholders, the company can survive despite changes and exit of shareholders.
Double Taxation: For most corporations, this means double taxation since shares may pay taxes on profits, and then companies are also tax required to pay corporate taxes on gains.
Ability to Raise Capital: Since corporations can issue stock, this can be an attractive feature for businesses that require large amounts of capital for growth.
Ownership Structure: LLC vs Corporation
LLC’s and corporation’s ownership structure shall always be comparable in terms of degree of flexibility, but management hierarchy, formalities, and the transfer of ownership are completely varied. These variations hence make one structure preferable over the other relative to the size of the business and its growth objectives.
1. LLC Ownership Structure
Members: Members can be either individuals or an entire corporation, even other LLC companies. There is also no upper limitation to the members of an LLC, obviously which favors small and medium-sized and family companies and partnerships. Ownership percentages and other effective roles of members can be specified and changed by the terms stated in the operational agreement of the LLC, hence leaving the scope for defining contributions of various members.
Flexible Management: An LLC may be member-managed or simply manager-managed. In LLCs that are considered to be member-managed, all the members take part in the decision-making process and the running of the company’s day-to-day affairs, and in the case of manager-managed LLCs, the members authorize one or more managers to take charge of the routine business activities which may be the members or even professional managers.
Operating Agreement: The agreement sketches out the interest and the profit-sharing ratio as well as the rights of each member to prevent clashes in the future. Generally, it provides for the admission of new members, the removal of existing members, and the transfer of ownership.
Ownership Transfer: In the case of an LLC, transferring ownership presents more legal impediments than in a normal company structure because it has been emphasized in the operating agreement that all member approval is normally sought in most cases. Many LLCs have these “right of first refusal” clauses under which the owners are obliged to give their member interest to the other members and not sell it to outsiders.
2. Ownership of the Corporation
Shareholders: In simple terms, corporations are owned by the holders of shares, who acquire units of ownership called shares. Each share gives holders certain rights, among them the right to vote on some key issues of the company and to receive dividends when they are declared. A feature of corporations is that the number of shareholders is almost unlimited, which is an advantage from the point of view of bigger companies or those that seek to raise something substantial through equity.
Administrative Roles: Corporations always have an organized and structured management hierarchy. Shareholders are the ones to elect a director’s board that bears the overall responsibility for directing and managing the corporation but in a nutshell, this board is the one that takes the most strategic decisions.
The board of directors of the company hires corporation officers, such as CEO, Vice President, Chief Financial Officer, and others, to carry out the daily functions of the corporation. This setting distinctively separates the ownership from the management of the business and enables shareholders to hold shares without engaging in the management of the business directly.
Corporate Bylaws and Shareholder Agreements: A corporation’s management, board election, and other matters related to organizational strategies are guided by laws that are also referred to as the corporation’s bylaws. There may also be specific agreements between shareholders that cover certain rights and obligations of the parties and conditions relating to changes in ownership. Such formalities ensure an orderly form of ownership and governance.
Offer of Ownership Interests with Ease: One of the compelling benefits of a corporation as opposed to an LLC, for instance, is the relative ease with which ownership interests can be transferred. When it comes to corporations, specifically those that are publicly traded, shares can be purchased and sold on the stock exchange. This ability makes it possible for ready transfers of ownership which do not affect the functions of the corporation, thus making it an ideal option for any company looking to expand their pool of investors or grow as it is.
Differences in Taxation Levels: An LLC Entity vs. a Corporation
An LLC and a corporation differ in how they are taxed and more often these entities characteristics will affect the tax liability of the business owners. Here is a guide on how taxes apply to each type of entity:
1. LLC Taxation
Pass-Through Taxation: An LLC by default qualifies for pass-through taxation in which a general rule applies that an LLC does not pay federal income taxes. There is also a provision that the profits and the losses of the business “pass through” and are reported on the member’s tax returns. This is taxation at individual income tax rates. This eliminates the problem of double taxation that corporations will have to deal with.
Single-Member LLC: A single-member LLC is referred to as a “disregarded entity” for tax purposes, which means the IRS does not distinguish between the owner and the LLC. Profits and losses from business operations are included in the owner’s tax returns under Schedule C of Form 1040.
Multi-Member LLC: For multi-member LLCs, the entity submits an informational document, 1065, and issues a K-1 to members to indicate their shares of income and losses which they attach to their individual income tax return.
Self-Employment Taxes: Members of the limited liability company are generally self-employed individuals, that is, they are to pay self-employment taxes (Social Security and Medicare) on the net profit of the business. This is an extra tax squeeze on the LLC members which may turn out to be more than what is suffered by employees of a corporation in terms of tax paid.
S Corporation Election: An LLC can also elect to be taxed like an S Corporation by filing IRS Form 2553. This allows profits to ‘pass through’ to the members but may ease self-employment tax as only salaries, not distributions, are incurred with self-employment tax.
2. Taxation of Corporation
C Corporation (Double Tax): C Corporations are recognized distinct entities for tax and are responsible for the payment of income taxes on profits earned by the corporation. If dividends are distributed to shareholders after the corporation pays taxes, such dividends will be taxed at the individual level. Such a situation leads to what can be referred to as “double taxation”.
Corporate Tax Rate: For a C Corporation, as of 2024, at the federal level, the corporate income tax rate is a flat rate of 21% although there may be state-level taxation for some states.
Shareholder Tax: Tax must be remitted on dividends received through ownership of shares from the corporation, typically, these dividends will be received at qualified dividend rates between 0 and 20% depending on the income received.
S Corporation (Pass-Through Tax): An S Corporation is a special tax status type that enables the complete avoidance of double taxation since it allocates earnings at the shareholder level as opposed to the holding company. However, more restrictions apply for S Corporations than for LLCs; they can have a maximum of 100 shareholders and only US citizens or residents can qualify.
Salary vs. distributions: S Corporations are similar to LLCs that have elected to be treated as S Corporations. An owner who is active in the business must draw out a reasonable salary, which is subject to payroll tax. Any additional earnings are considered dividends, and these are not subject to self-employment tax, thus reducing the overall tax payments.
3. The Most Important Divergences in Taxation of LLCs and Corporations
Double Taxation (C Corp): Corporations have double taxation (taxed at the dividends’ corporate level and then again at the shareholder level), whereas LLCs have to declare this through members’ returns and avoid corporation-level taxes.
Self-Employment Taxes: All business income is subject to this tax, which means that in most cases piece members of the LLC will have to pay self-employment taxes much higher than owners of S Corporation have to do with distributions.
Tax Strategies: LLCs remain more versatile in the manner in which they will be taxed. For example, an LLC can opt to be taxed as a sole proprietor, a partnership, an S Corporation, or a C corporation, which is advantageous to its needs. In contrast, once incorporated, corporate tax status is fixed. C corporations are double taxed while S corporations are flowing through.
State Taxes: Funds may be owed to the state as either an LLC or corporation, and the amount owed will vary. There are also certain LLC taxes or franchise taxes applicable in certain states that may also compound the overall tax load.
Formation and Maintenance: Costs and Requirements
The costs, legal formalities, and ongoing compliance obligations for forming and maintaining an LLC and a corporation differ. Below are the summary points for the two entities:
1. LLC Formation and Maintenance Costs
Formation Costs:
State Filing Fees: The fees money companies file for an LLC often depend on the state’s regulations and may fall between $50-500 USD. The reverse is true, however, in states like Delaware that charge higher fees compared to those with lenient fees like Wyoming.
Name Reservation Fees: If you want to reserve your LLC name without filling and filing papers, you might have to pay some nominal fees (generally ranging between $10 to as much as $50), but in most states, this step is not compulsory.
Operating Agreement: Although not a legal requirement in every case, it is worth mentioning that making an Operating Agreement that states the organizational structure and how the LLC will be managed is very advisable. The company may incur legal or professional expenditures if in cases you choose to retain a lawyer or buy online legal services, this range varies from $100 – $500.
EIN (Employer Identification Number): It is free to receive an EIN from the IRS, but it is important for employment, taxes, and other business-related purposes.
Ongoing Maintenance Costs:
Annual Fees: Almost all states require LLCs to file annual or bi-annual reports, which have fees ranging from $20-$200. Not filing can result in a certificate of good standing or even getting struck off the register.
State-Specific Taxes: Illinois has a franchise tax of $100 whereas other states have an Annual LLC tax.
Registered Agent Fees: If the registered agent is to be hired then this service is around $100-300 annually.
Ongoing Requirements:
Annual Reports: Depending on the state, an LLC may be required to file an annual report updating the state on the business’s status. The cost of filing these reports is generally low but necessary to maintain good standing.
Operating Agreement Updates: However avoiding endless action would not be the case for future internal divisions and disputes.
2. Formation and maintenance of a corporation
Formation Costs:
State Filing Fees: The cost to form a corporation usually does not go beyond $100-$500 in most states. Delaware and Nevada may also impose higher fees; however, they are still reasonable when compared to some other states.
Articles of Incorporation: To establish a corporation, articles of incorporation must be submitted to the state. A nominal fee, usually incorporated in the constituency amount, is usually charged for this service. This legal attachment states the particular focus of the corporation and the shares, etc.
Bylaws and Corporate documents: You are not obligated to file bylaws with the state and all other necessary documents but creating them is important for the internal management of the corporation. You might also need to have lawyers prepare the bylaws which can cost anywhere between $200 and $1000 or so, depending on how complicated those bylaws are.
EIN: Just as with LLC, the EIN which is from IRS is at no cost and is needed for tax obligations, a bank account, and employment.
Ongoing Maintenance Costs:
Annual fees and reports: Most states demand annual reports from corporations which attract a fee of about $50 – 300. Non-filing of these reports will subject the corporation to penalties or even dissolution of the corporation.
Franchise Taxes: A few of the states enforce franchise or minimum corporate taxes. For example, Delaware assesses franchise tax on the number of shares provided, and this can be about $200-$500 reasonable on an annual basis.
Registered Agent Fees: A corporation that wishes to employ a registered agent to receive and deal with the lawful papers should be prepared to pay between 100 to 300 dollars every year.
Ongoing Requirements:
Annual Shareholder and Director meetings: Every corporation cannot avoid the obligation of inviting its shareholders and directors for annual meetings even if there are no critical resolutions taken. While these could be routine, it is important to keep proper records of the proceedings and their outcomes and file them for record.
Board of Directors: Corporations are legally obligated to have a board of directors and corporate governance entails the necessity for the corporation to meet the legal requirements.
Corporate tax returns: Corporations are required to prepare and submit distinct tax returns (C Corps File Form 1120) and pay corporate tax income rates. Tax preparation varies in cost a great deal depending on how involved the nature of the business is.
Raising Capital: Advantages of an LLC and a Corporation
In business development, one of the very basic aims is raising capital, and the members’ organization of the business determines the readiness to invest in the business. This is how LLCs and corporations stand when it comes to raising capital:
1. LLC and Capital Raising
Ownership Adjustment: LLCs have unique ownership structures that can be held by both individuals and institutions. It is permissible to form an LLC with many members which may include, other LLCs, companies, and foreign nations. This gives most small to medium-sized businesses an advantage when raising capital since various sources can be tapped.
Private Investment: Private investments from members or other outside investors are frequently used to finance LLCs. This, however, may restrict their potential for growth as they lack a public equity market or shares to issue, which corporations seem to blanket.
Equity Financing: Though LLCs can raise equity through membership interests (ownership stakes), these stakes are more like assets than stocks in a public company. This situation makes it more difficult to lure larger-scale investors who may favor the liquidity and organization that stocks do cabinetry to larger investments where liquidity is needed.
Loans and Debt: LLCs can borrow money or raise capital by issuing debt securities, but chances of attracting such financing may be slightly dim, as investors would be averse to investing in LLC, as the latter does not have a well-defined structure like that of a corporation.
2. Corporation and Capital Raising
With regards to the corporate structure of an organization, its major advantage, especially with a C corporation, is “raising stock” which makes it easier to go public and allow space for listing shares on stock exchanges. This provides access to a whole new pool of investors, many of whom are corporate entities rather than ordinary retail investors.
Equity Financing: Institutions can elevate ownership interests by issuing varied stocks such as common stocks and prevailing stocks. Since Preferred stocks are more secure than common stocks, this type of investor finds it beneficial to make more investments in captive firms, adventure firms, or private equity key players. Other types of investors also tend to take advantage of this stipulation, which enables sellers of interests greater flexibility in selling shares.
Venture Capital and Angel Investors: Venture Capitalists (VCs) and angel investors prefer investing in Corporations because of their ability to issue stock and preferred stock that can be liquidated when needed across the stock. It’s common for VCs and angels to invest in corporations because it is easier to exit the business by selling stocks in particular through acquisition or IPO.
Debt Financing: Moreover, corporations can also tap the capital markets in the form of debt through the issuance of bonds or debt instruments. Bigger corporations with good performance records and good credit ratings will be able to gain better access to the capital markets for the Issuance of corporate bonds, thereby drawing in institutional investors.
Share Liquidity: Shares of stock in corporations can be transferred, sold, or traded with relative ease when compared to membership interests in a limited liability company (LLC). This liquidity enhances the prospects of corporate investments by investors with a strong desire for an exit mode or investment with share sale options.
Pros and Cons of an LLC
Pros of an LLC:
Limited Liability Protection:
Participants in an LLC (called members) enjoy the benefit of limited personal liability which ensures that their assets are in most cases protected from the company’s debts and legal claims. This is perhaps one of the key benefits of the formation of an LLC over a sole proprietorship or a partnership.
Pass-Through Taxation:
As important as it may seem to understand the legal structure to consider the income taxation regime concerning an LLC, it suffices for one to note that an LLC is taxed through the owner’s taxes. This translates to avoiding the double taxation over profit that a corporation may face. Most pass-through members then pay only a single tax over their earnings which lowers the overall tax burden.
Flexible Ownership Structure:
With members being possible an unlimited number of members regardless of whether natural persons, legislative bodies, or other legal entities, they become ideal for both small and larger businesses. This enhances the capacity of an LLC to enhance an ideal business model.
Operational Flexibility:
Unlike the formal management structure that is pronounced in most corporations, LLCs are not required to formulate a management team. Some members can directly control the operations of the business (member-managed) while some may opt to hire someone to run the affairs of the business (manager-managed). Such flexibility ensures the business can be managed in a simple bureaucratic way within corporations.
Fewer Formalities:
There are no similar levels of corporate requirements for LLCs and corporations. Other than an annual overview, there is no need for business meetings and chronicling the minutes of such which helps in lowering administrative stress levels and expenses.
No Restrictions on Foreign Ownership:
One other beautiful thing is that LLCs can have foreign members. This enhances the attractiveness to foreign investors who want to set up in the US.
Cons of an LLC:
Self-Employment Taxes:
Typically, LLC members have self-employment taxes such as Medicare and Social Security imposed on them for their share of the income generated by the company. In comparison to otherwise corporate shareholders, this could be considered a huge drawback to LLC owners who do not pay such self-employment taxes on dividend distributions.
Limited Ability to Raise Capital:
In comparison to corporations, LLCs find it difficult to raise capital. They can’t sell stocks and venture capitalists or institutional investors tend not to be very interested in them as they prefer the stricter framework and the chance for returns through equity in a corporation.
State-Specific Regulations and Fees:
The Rules, regulations, and Fees associated with LLCs are not the same across the states. Other states also have some annual fees, franchise taxes, and other forms of payments that become burdensome over time. For instance, California requires that all limited liability companies pay an annual minimum franchise tax, and Delaware on its part requires an annual LLC fee.
Complexity in Ownership Transfer:
Ownership transfer in an LLC can be somewhat more difficult than in a corporation. Selling or transferring membership interests typically requires consent from the other members of the company. This situation can restrict the liquidity of ownership interests of an LLC.
Limited Lifespan:
Depending on the state, members of an LLC have a limited lifespan. This can be set at several years, or an LLC that has no operating agreement dissolves automatically when a member dies or withdraws. This is different for corporations that have no limit at all in their lifespan.
Higher state taxation may apply:
Another disadvantage is that some of the states will apply higher taxes to LLCs than they will apply to corporations. These include franchise taxes and sometimes other business taxes. Also, some states such as California apply the minimum LLC fees every year irrespective of whether there was any income earned or not, which increases the operational cost of LLCs.
Pros and Cons of a Corporation
Pros of a Corporation
Limited Liability:
A shareholder or an owner of the corporation has no obligation or responsibility to settle the debts of the corporation or other legal undertakings. This means that their assets will be protected. This is a great option for companies who desire to limit personal risk as a corporation. Also, Read legal Structures for a business
Access to Capital:
Raising capital is another great benefit, which is beneficial for a corporation’s growth. This can be achieved as corporations can sell stock (common and/or preferred), which is appealing to investors, thus assisting in the growth of the company. They can also issue bonds and go to public markets through an IPO.
Perpetual Existence:
One of the characteristics of a corporation is that it can survive regardless of changes in ownership or the death and/or withdrawal of some of the members. Because of this, if a business wants to operate for a long-term period, this characteristic offers stability and continuity to the business.
Easier to Attract Investors:
It is more appealing to venture capitalists, angel investors, and Institutional Investors as they can issue shares and have a more defined governance structure. Because of the formal structure and scalable nature of the corporation, investors prefer this type.
Transferability of Ownership:
One of the advantages of being a shareholder of the corporation is that it is relatively easy to buy and sell shares thus making liquidity easy and creating an active market for the shareholders. Compared to an LLC, where ownership transfers are often more complex, this makes it easier to transfer ownership.
Tax Deductibility of Benefits provided:
Corporations can offer employee benefits including health insurance, retirement benefits or even bonuses, and other work incentives that are tax deductible, a move which is advantageous when trying to woo good employees.
Credibility:
Being a corporation may enhance greater creditworthiness in the eyes of customers, suppliers, investors, and even lenders. A more structured format of governance may create a perception of respectability and professionalism that may not be well perceived in LLC or sole proprietorship.
Cons of Corporations
Double Taxation:
One of the largest complaints within a corporation, especially within a C Corporation, is double taxation. The corporation itself gets taxed on profits, and then shareholders have taxed dividends when and if they ever receive them. This could lead to a greater tax liability than limited liability companies, where such entities benefit from having a pass-through taxation structure.
Difficult to Form and Manage:
Corporations are intractable in terms of establishing and managing them, unlike LLCs. This involves the filing of an article of incorporation, forward to the adoption of bylaws, and the composition of the board. Corporations have also to comply with more stringent regulatory and governance provisions including year no distributions to shareholders and availability of corporation minutes.
More Administrative Costs:
There are many formalities to be complied with due to the legal form of incorporation such as establishing a board of directors, summoning and documenting meetings, preparing and submitting statutory filings periodically, and maintaining certain corporate books which lead to increased administrative expenses. You may even be required to bring in additional professionals (like accountants and lawyers) for compliance purposes.
Limited Number of Owners:
Certain corporations, especially S Corporations, have limitations on the number of shareholders they can have as well as the types of shareholders. To illustrate, S Corporations can only have up to one hundred shareholders who all have to be citizens or residents of the US and cannot have partnerships or corporations or non-resident aliens owning shares in them.
Tighter Regulatory Environment:
Corporations for instance are required to adhere to more stringent federal, state, and local statutory requirements than LLCs for instance. They have to prepare and file enhanced filings about perpetual activities, obtain compliance with securities laws if publicly traded, and keep detailed records, all of which add up to the regulatory burden.
LLC or Corporation. What is the better choice for a small business?
While a limited liability company (LLC) may be the best option for many small businesses, the choice mainly depends on the situation. Read on to learn more:
LLC: Best for Small Business
Simplicity and Cost Effectiveness: Forming and maintaining LLCs is much less complicated and expensive than that of corporations. They also require less formality such as no requirement for annual meetings or even a board of directors, which is most suited for small business owners who do not wish to complicate their operations.
Avoidable Double Taxation: LLCs do not subject the profits to “double taxation” as income earned at the corporate level is taxed, and the income distributed to the shareholders is also taxed. This will greatly relieve the overall tax burden on small business owners.
Limited Liability: An important feature of all LLCs is the protection from personal liability. This means that the owners will not be personally responsible for any debts incurred by the business, which is a crucial feature for small business owners.
Ownership Freedom: Because of the relaxed ownership rules, the management of LLCs can also be quite different which means that it could be used for different types of businesses.
Corporation: Bad Choice for Small Business
Complexity and Cost: Corporations are also more expensive to set up and maintain as they are required to have anniversaries with more paperwork such as yearly meetings, a board of directors, and complete minute book records. Small business enterprises would find such formalities cumbersome.
Double Taxation: This is particularly the case for C Corporations which are often said to experience double taxation since the earnings are taxed at the corporate level where profits are earned and again when the company pays dividends. This may not be good for small businesses that do not wish to plow back a bulk of the profits into the business.
Easyfiling can help setup both LLC and Corporation
At EasyFilling, we assist in the formation and running of LLCs and corporations aimed at small business owners who are concerned with the growth of their businesses without the bother of dealing with too much legal paperwork.
If you decide to establish an LLC for its numerous advantages such as flexibility and taxation then EasyFiling is always there to help you along with the establishment of a Corporation to expand and create a market.
We do registration and compliance and regular servicing of management making adherence to the legal formalities of setting up and running a business very easy. With EasyFiling you are in a position to decide what structure to use and start up your business instantly and confidently.
Book a free consultation for clear guidance on setting up your LLC or Corporation business.
Nabin Adhikari
