LLC vs Corporation: Which One Will Serve You Best in 2021?

It is a requirement by many states that organizations should register a specific business entity with the state where they operate their businesses. While there are several business entities to choose from, most business owners choose either a corporation or limited liability company mainly due to their protection capabilities.

Surprisingly, these two business structures are more different in their operations than they are similar. However, understanding the differences can be overwhelming particularly among small business owners who are getting started. To help you make the right decision for your businesses in 2021, we have provided a comprehensive side-by-side LLC vs corporation comparison. In our comparison, you will learn the differences right from their meanings, benefits, business formation, liability protection to taxation and much more. We have also shared some of the similarities as well as step by step guide on how you can set up each structure.  

Let’s start by clarifying the meaning of these two business entities.

Corporations, LLCs, and Limited Liability

Corporations and LLCs are popular for their ability to offer liability protection. As a matter of fact, an LLC and a corporation keep their business operations separate from the owners’ personal activities and therefore are held accountable for the business liabilities such as debts. Meaning, in the event of lawsuits or any losses caused by the business, your personal assets will not be used as collateral to repay the business losses. 

With that being said, let’s see the difference between an LLC and a corporation in detail. 

Limited liability company (LLC) 

An LLC is a hybrid business entity organized in the US under state laws. State laws governing the LLC are unique to each state. In Washington for instance, it is protected in chapter 25.15 of Washington State Legislature[1].  

The entity is described as a hybrid because it offers liability protection capability of a corporation and the tax efficiencies & operational flexibility of a partnership and sole proprietorship. The protections offered by an LLC are sufficient enough to keep your personal assets like your house, vehicle, and savings accounts from being used as collateral to repay the business debt, bankruptcy, or lawsuits. 

By default, LLCs are treated as ‘pass through’ entities for taxation purposes. The company income is distributed among the members who then report to their individual tax returns. However, the company can as well choose to be taxed as a corporation so that members can avoid being treated as self-employed. 

Corporation

A corporation is a business entity that is distinct from its owners. It is often referred to as a legal person because it enjoys rights and responsibilities that individuals possess. For instance, it can loan and borrow money, enter contracts, sue and be sued, own assets, hire employees, and pay taxes. 

Corporations can be classified into the following subchapters:

C corp

The C-corporation is the standard corporation under IRS rule. C-corporation’s biggest win is its stronger protection to its owners with a complete life separate from shareholders. That is to say, if a shareholder decides to leave or sell his/her shares, the corporate can continue doing business undisturbed. 

Besides, this business structure is also very effective when it comes to raising capital. The shareholders can sell stocks to raise funds and attract employees. 

On the negative side, the cost of setting up a C-corp is higher than forming an LLC. It also requires extensive record-keeping, reporting, and operating processing. Even more, their double taxation method isn’t good news either. 

S corp

S-corporation is a special type of corporation popular for its tax advantages. This entity type is designed to help corporation owners avoid possible double taxation of the standard C-corporation. S-corporations are not subject to corporate income taxes, and therefore, there is not an “S-corporation tax rate.” Instead, the organization’s owners split the income or losses amongst themselves and pay individual taxes.

Apart from special tax treatment, S-corporations have strict restrictions. For instance, S-corp shareholders must be US citizens, specific trust & estates, or organizations with tax-exempt status. For that reason, consult attorneys to inquire whether your company qualifies to form an S-corporation.

B corp 

These are new types of businesses that balance purpose and profit. B-corp’s[2] biggest win is transparency and accountability.The owners are required by law to consider the impact of their decision on workers, suppliers, community, and environment. In that connection, some states demand that B-corporations submit an annual report as proof of public participation. 

However, other aspects like taxations are similar to C-corps. 

Advantages and disadvantages of an LLC vs. a corporation

Still confused? Here is a summary of LLC vs Inc pros and cons to help you understand these two structures further. 

Advantages

Limited Liability Company

  • LLCs require little paperwork during the formation
  • It is a hybrid structure with protection capabilities of corporations and tax flexibility of a partnership.
  • LLC owners can elect to be taxed as a C-corp or an S-corp for tax purposes. 
  • LLC owners enjoy good privacy protection in some states like Wyoming

Corporation

  • Have a complete life separate from its owners
  • S-corporations are not subjected to double taxation.
  • They offer excellent privacy protections. 
  • Guarantee more flexibility when it comes to their excess profits
  • Shareholders are treated as employees, not as self-employed. 

Disadvantages

Limited Liability Company

  • Profits are subjected to social security and medical taxes
  • Have limited life separate from members in many states.
  • Members are treated as self-employed and therefore are subject to self-employment taxation.

Corporation

  • C-corps are subject to double taxation
  • S-corps have rigid protocols to follow.
  • Setting up a corporation involves a lot of paperwork and is more expensive compared to LLC.  

Difference Between LLC and Corporation

The differences in operation between a corporation vs LLC has been crafted to help you understand what your company needs with a lot of ease. Here are some of the main differences between an LLC and an INC.   

How the Business is Formed

Even though they both require paperwork and some money during formation, the amount of paperwork and filing charges are not the same. The articles of corporation are more comprehensive than LLC’s articles of organization. You should be aware of the differences between these two documents when making the LLC vs Inc decision. 

During LLC formation, the members file articles of organization with the secretary of the state then draft an operating agreement that is used in the day-to-day running of the business. 

On the other hand, forming a corporation involves the filing of the articles of corporation then creating the board of directors to oversee the corporate business. It is this board of directors that represents the shareholders, appoints the CEO and the business manager. 

Business Ownership

An LLC is formed and owned by one or more business owners called members while a corporation is formed and owned by shareholders or stockholders. LLC owners invest to join the business and therefore have an ownership interest in the assets of the business while corporate shareholders have shares of stock in the business.  

No restrictions on the number of owners LLCs and C-corporations can have. However, S-corporations are restricted to 100 shareholders who must be U.S citizens. 

Taxes

LLC taxation

An LLC can be classified as a partnership or disregarded entities [3] for taxation purposes. A multi-member LLC classified as a partnership must file form 1065 US return of partnership income. On the other hand, a one-member LLC classified as disregarded file the owner income tax return form 1040. 

However, LLCs give better tax flexibility than sole proprietorships and partnerships. You can choose to be taxed as S-corporation to enjoy more tax benefits or choose to be treated as C-corp for federal income tax purposes. 

Corporation taxation

Normally, a corporation is a separate tax entity. Meaning, C-corporation or B-corp sorts out income, deductions, losses, and credits and pays corporate income tax directly, not through the owners. 

In most cases, the company pays shareholders some dividends from after-tax profits or income. These dividends are always regarded as shareholders’ income and therefore, the shareholders have to pay personal income taxes on the dividends. That way, shareholders are subjected to double taxation. 

However, you can elect to be taxed as S-corporation to avoid such double taxations. S-corporations don’t pay corporate income tax, but rather are “pass-through” entities. The shareholders receive income or losses, split them amongst themselves, and pay their taxes individually. 

Self-Employment Taxes 

LLC members are treated as self-employed business owners or a sole proprietor in case of a single-member LLC for taxation purposes. For that reason, it is upon members to set aside enough money from their share of the profit to report to their personal tax returns. Shareholders, on the other hand, are treated as employees of the company and are therefore not subjected to self-employment taxation. 

The good news, an LLC owner can elect to be taxed as an S-corp. The greatest benefit of S-corporations taxations is that S-corps don’t have to pay self-employment taxes because owners are considered employees. 

Legal Entity vs. Tax Entity

A corporation is a legal entity separate from its owners with all the rights and responsibilities individuals possess and therefore guarantee protection to your personal assets. On the other hand, an LLC is a legal entity with liability protections of a corporation and tax flexibility of a partnership and a sole proprietorship. 

A Corporation is a separate tax entity and the company files the tax return directly, not through the owners. On the other hand, LLC is a “pass-through” entity. The member(s) pay their share of profit on their personal tax return (Form 1040 or 1040-SR). They are considered self-employed and have to pay self-employment tax contributions towards Medicare and social security.  

Asset Protection of Each Entity

Even though these two structures offer asset protection, corporations, corporations guarantee stronger protections with a complete life separate from shareholders. If a shareholder decides to leave or sell his/her shares, the company can continue doing business undisturbed. 

On the other hand, LLCs have limited life in many states. In such states, when a member leaves or joins an LLC, it may be required that the LLC be dissolved and reformed with new membership. However, an LLC will offer you a more protective membership option than S-corporation. 

Profits and Losses

Corporate losses and profits are held by corporations and the shareholders may only be paid dividends from after-tax income. The company then sorts out the profits and losses and pays income tax directly.

Just like a partnership and a sole proprietorship, an LLC income passes through to individual owners. That is why LLC is described as a “pass-through” entity. The owners pay their shares of the business income on their personal tax returns. 

Similarities Between LLC vs. Corporation

Registered Business Entities

Both corporations and LLCs are registered business entities recognized by the states. When you incorporate a business or form an LLC from sole proprietorships or partnerships, you evolve into a company that is recognized in the state where it is incorporated or formed. 

Limited Liability Protection

Both LLCs and Corporations offer limited liability protections. They own the business plus all its assets, debts, and liabilities such that your personal assets and business assets are separate entities. In the event of lawsuits, your personal properties such as vehicles, houses, and personal bank accounts remain protected. 

LLCs and Corporations limited liability protections are well-established and respected rules. However, that doesn’t mean the shareholders and members can never be liable for anything. They can still be held accountable for their wrongdoings. For instance, if the owners breach the operating agreement. 

Is an LLC or corporation better for my business?

Yes. Every owner of both corporations and LLCs is protected from personal liability for business lawsuits or debts. LLCs are good choices for small owner-managed businesses that require flexibility without a lot of corporate formalities. Corporations are favored by businesses that seek outside investments. 

We would advise consulting with attorneys or incorporation specialists as a complement to our LLC vs Inc guide. 

What’s Best for Foreign Investors?

LLCs have now replaced limited partnership as the business structure of choice for holding investment real estate. The LLC offers a much better liability protection particularly to a single-member LLC. 

Besides, forming an LLC is easier and cheaper than most structures. As a foreign investor, you will not like a lot of paperwork. 

Setting up Your LLC or Corporation

The rules on how LLCs and corporations are formed vary from state to state. Besides, the requirements will also be dictated by the complexity of your organization. Here is a simple guide on how to form each.

LLC Formation

  • Choose your state for the business formation. 
  • Get a registered agent.
  • Get a copy of your state’s LLC articles of organization from your state secretary’s website or office. 
  • Choose a name for your business that complies with your state’s rules for LLC names. 
  • Fill in the required information on the LLC article of organization form
  • Publish a notice in your local newspaper if your state requires you to do so.
  • Submit your articles of organization form to the secretary of the state along with your filing fees. 
  • Make a written agreement of terms with your partner; the LLC operating agreement. This is not a mandatory requirement but very important if you are not the sole owner of your business. 

Note:

i) always spell out all the financial and management rights and responsibilities of LLC members when creating an LLC operating agreement.

ii) If your organization is fairly complex, you may seek the assistance of attorneys or online filing companies.

iii) Set up your LLC in the state you are planning to do your business or you can consult with your attorney on our state registration requirements.

Corporation Formation 

  • Select a state.
  • Decide on a name depending on your state requirements. 
  • Conduct a name search and ensure you select a unique corporate name.
  • Obtain your articles of corporation, fill in the necessary business information, have it signed, and file with the secretary of the state along with the required filing fees. 
  • (It is at this point when you can form a board of directors)
  • Draft corporate bylaws if your state requires so.
  • Draft a shareholder agreement for the day-to-day running of the business.
  • Maintain corporate minutes with shareholder meetings and board of directors
  • Issue shares of the stock and update the corporation’s shared ledger.
  • Get employer identification number (EIN) or the corporation’s social security number from irs.gov.[4] 
  •  Select a tax election: You can elect to be taxed as either S-corporation or C-corporation.

In those simple steps, you will incorporate your business in most states. What remains will now depend on your business or your state’s unique requirements.

Conclusion

Our LLC vs corporation comparision has been crafted to help you decide on the best entity to incorporate your business without the hassle. LLC is great for small business owners who want flexibility without a lot of corporate formality. On the other hand, small and large owner-managed businesses seeking outside investments should pick corporations. 

As always, we recommend you take your time and consideration before you make your decision. Once you arrive at your decision, feel free to share with us the experience with your pick. 

Frequently Asked Questions

Is an LLC a corporation?

An LLC is a different business structure from a corporation but with the limited personal liability protection of a corporation. As clarified in our comprehensive LLC vs Inc comparison, these two structures differ in many aspects right from formation, ownership, taxation, asset protection capability among others.

How to change an LLC or Corporation?

Changing an LLC to a corporation is possible but it is a complex process. To begin with, LLCs have different tax status; can be taxed as a partnership, corporations, and disregarded entities. Two, C-corporations and S-corporations have different taxation processes. For that reason, consult with attorneys to know your state requirements.

What certificates are required for an LLC or Inc?

For an LLC, you will be issued with a certificate of organization to show the LLC was duly formed and recognized as a legal entity by the state. In addition, a membership certificate is also issued to each member to show their claim to the organization. Corporations also require that be issued with a certificate of incorporation.

S-corp vs LLC: Which is the best for your business?

S-corporation is a business entity with some strict restrictions including 100 maximum shareholders and is designed for the US alone. For that reason, it is not an established business entity like an LLC but rather an elected tax status. However, S-corporations guarantee more tax savings than any other entity. 

Do corporations pay more taxes than LLCs?

C-corporations distributions are taxed at both corporate and shareholder level. An LLC or S-corporation is however taxed once. For that reason, C-corporations usually end up paying more in taxes than LLCs and S-corporations.

LLC vs Inc: which is the best for a small business owner?

LLC is always the best choice for small businesses because it offers a sufficient amount of liability protection with minimal paperwork. At the same time, it is cheaper and simple to form.

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