LLC vs Corporation: Which is Right for Your Business?

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LLC vs Corporation

An LLC is much easier to set up and maintain than a corporation. The simplicity and lower costs make it a good choice for most small businesses.

One of the main differences between LLC vs corporation is that one or more individuals own an LLC, while shareholders are the owners of a corporation. Both LLCs and corporations will generally protect you from personal liability for claims against the business. Only a corporation, though, can issue stock to sell ownership shares of the company to investors.

While most solo and small businesses will choose to form LLCs, you do need to consider the future. If you plan to attract investors later on, it may be better to create a corporation at the outset, rather than having to change your business structure later.

You also have the option of creating a hybrid structure where you register as an LLC but choose to pay taxes as an S corporation or a C corporation.

An attorney or tax advisor can guide you in choosing the business structure that will best meet the needs of your company, now and in the future. To be a savvy business owner, you must avoid some tax planning mistakes.

Management of LLC vs Corporation

Most of the paperwork involved in owning an LLC takes place at the outset when you first create the LLC. After the LLC has been registered and you’ve created an operating agreement, there are few remaining formalities required.

Depending on the state, you may need to file an annual report. If you have a multi-member LLC, it’s a good practice to hold regular meetings of the members, but that’s not a requirement.

Because LLCs have fewer formal requirements, their annual fees (if any) to the state are usually lower than what corporations have to pay, and LLCs usually have less need for and spend less on accounting and legal services.

LLCs have flexible management requirements. You can choose to have all of the LLC’s owners manage the day-to-day operations or you can assign decision-making power to specific members or outside parties.

Corporations have far more mandatory actions and record-keeping requirements they must fulfill to remain in good standing. These generally include:

  • Creating and updating corporate bylaws.
  • Holding annual shareholder meetings.
  • Electing a board of directors.
  • Holding regular meetings of the board.
  • Voting on any changes or actions of the business at board meetings.
  • Document meetings with corporate minutes.
  • Issue stocks and shares.
  • Record transfer of stock.
  • Create formal financial statements.
  • Provide shareholder reports.
  • File annual reports.

The management structure of a corporation is less flexible than an LLC. The responsibility for managing the corporation to generate profits rests with the board of directors. Corporate officers manage the day-to-day operations. Shareholders have the power to elect directors. However (unless they are also directors or officers), shareholders aren’t involved in decision making or day-to-day operations, except when major decisions are put up for a shareholder vote.

Taxes Paid by LLC vs Corporation

If you have an LLC, you have more flexibility when it comes to paying taxes than you would with a corporation.

For most LLCs, the income and expenses of the LLC pass through to the owner or owners. Each owner then reports the profit or loss on their personal income tax returns. This is similar to the way a sole proprietorship works and is the way that most LLCs operate.

One tax disadvantage of being an LLC owner is that you need to pay self-employment tax, which was 15.3% in 2022. The tax includes both the employees’ and employers’ portions of Social Security and Medicare taxes (FICA taxes). Compared to an employee, an LLC owner will be paying twice as much in FICA taxes.

LLC owners also have the option of choosing to have their LLC be taxed as an S corporation or a C corporation. In an LLC that is taxed as an S corporation, the income passes through to the shareholders. In an LLC operating as a C corporation, the business has to file a separate corporate tax return.

Corporations can only operate as S or C corporations. Most are C corporations that are required to file corporate income taxes separately from the corporation’s owners.

A tax disadvantage for corporations is that taxes are paid twice on the same income. This is known as the “double taxation” problem. Corporations pay taxes on earnings on their corporate tax returns, and shareholders pay taxes on dividends from the corporation on their personal tax returns. However, corporations can avoid some of the double taxation by reinvesting a portion of their income back into the business.

Corporations can choose to be taxed as S corporations, which eliminates the double taxation problem, but that requires putting significant limits on how many shares the corporation can issue.

Formation of LLC vs Corporation

Forming an LLC is much simpler and requires fewer steps and less paperwork than forming a corporation. You can register an LLC online in just a few steps, while starting a corporation will most likely require prior counseling with either a CPA or a lawyer to properly understand the way you want it built.

LLCs are created according to state law, so the exact procedures will vary from one state to another. In general, the main requirement will be to file a form called the articles of organization with the Secretary of State in the state where your LLC is located.

It’s not required, but it’s strongly recommended, that you also create a document called an operating agreement. This document sets out the roles and responsibilities of the members of the LLC. It provides ongoing guidance in running the LLC and helps prevent disputes in multiple-member LLCs.

Forming a corporation requires a lot more steps. You’ll need to appoint directors, file articles of incorporation, write corporate bylaws, create a shareholder agreement, hold the first meeting of the board, issue stock, and register the corporation, which you can do online.

Conclusion

When deciding whether to structure your business as an LLC or a corporation, you’ll need to consider:

  • Your current business structure, if any.
  • How many employees you plan to have, if any.
  • Goals for future expansion.
  • How much paperwork and government requirements you are willing to deal with.
  • Whether double taxation would be a problem.

LLCs have the advantage of being simpler and less expensive to set up and to run. For many small businesses, an LLC may be all that they need.

Corporations have the advantage of being able to issue stock to raise money from investors. They have the disadvantages of having to comply with more government regulations, require more ongoing paperwork, and create the problem of double taxation. They also are less flexible in their tax options than LLCs.

Most people who are sole proprietors or own small businesses and choose to create more formal business structures will opt to form an LLC. The simplicity and lower costs are very attractive, and unless the business owner plans to seek investors, there may be no advantage to forming a corporation instead.

However, if you think you may be seeking venture capital in the future, or if you have expansion plans that could benefit from offering stock options to attract top employees, then you should consider forming a corporation at the outset.

A business attorney or a tax professional can provide advice on whether an LLC or a corporation would be the better choice given your business activities, budget, and plans for the future.

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