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What Is the Difference Between a Limited Liability Company and a Corporation?

Both LLCs and corporations are legal entities that protect their owners from personal responsibility for the debts and obligations of their businesses. Formation, ownership, governance, and taxation are all different. LLCs have less governance requirements and have the option of being taxed as either a C-corporation or a pass-through company.

One of the most critical choices you’ll make when establishing a small company is how to organize your business organization. Small company entrepreneurs often opt to form their businesses as limited liability companies (LLCs) or corporations. According to the National Small Business Association, S-corporations account for 42% of firms, while limited liability companies account for 23%. (LLCs). [1]

Your decision between an LLC and a corporation will have an effect on two important factors for every small company owner: money and time. Your tax burden, capacity to obtain funds from investors, and ease with which you may grow in the future are all influenced by the legal structure of your company. The time you spend educating your company entity and keeping it in good standing is also affected by the LLC vs. corporation choice.

The Differences Between a Limited Liability Company and a Corporation

The distinction between a limited liability company (LLC) and a corporation (corporation) may seem a bit hazy. However, the distinctions are likely to be the most important for your company. In terms of creation, ownership, taxation, and governance, LLCs and corporations are not the same.

Formation

When establishing an LLC, you must first submit a document known as the articles of organization with the business filing agency in your state. Basic information about your LLC is included in the articles of incorporation, such as the LLC’s name, address, and the names of the LLC’s owners. Following the filing of your articles of incorporation, you should write an LLC operating agreement. An LLC operating agreement serves as a blueprint for your company, outlining the partners’ relative interests in the company as well as their rights and duties.

S-corporations and C-corporations are the two kinds of corporations. In any instance, you must first file articles of incorporation with the business filing agency in your state. Basic information about the business is included in the articles of incorporation, such as the company name, location, and number of shares. After filing your articles of incorporation, you must execute a number of procedures that aren’t needed for LLCs to complete the setup process. Create company bylaws, elect a board of directors, convene the first board meeting, convene the first shareholder meeting, and issue stock.

Ownership and Fundraising

The ownership structure of a corporation is more complex than that of an LLC, but it is the preferable form if you intend to acquire money from investors in the future.

Shareholders, directors, and officers are the three parties that share responsibilities in a company. The company’s stock is owned by its shareholders. A board of directors is elected by shareholders and is responsible for long-term strategic planning. The board of directors appoints executives to manage the company on a daily basis, such as the CEO, CTO, and CMO. A one-person company, in which the owner is the only shareholder, director, and officer, is fully conceivable.

Members are the proprietors of a limited liability company (LLC). A single-member LLC with one owner or a multi-member LLC with many owners are both possible. In certain multi-member LLCs, known as member-managed LLCs, all members are involved in the day-to-day operations of the company. In some LLCs, known as manager-managed LLCs, members select one of their own or an outsider to run the company.

In most instances, investors prefer to deal with corporations rather than limited liability companies.

A corporation’s stock is intended to be readily distributed to investors, and investors may easily maintain their stake in the business by retaining shares or sell stock to divest their investment in the company. Different classes of shares are also allowed in C-corporations to attract venture capitalists and angel investors. It is feasible for an LLC to obtain investment, but it is considerably more difficult, and many investors prefer to deal with companies exclusively.

Taxes

are one of the most significant distinctions between corporations and limited liability companies. Corporate income tax applies to a C-corporation. An LLC’s owners may select whether the company is taxed as a C-corporation or as a pass-through entity. Pass-through entity owners must report their company revenue on their personal tax filings.

Due to double taxes, many businesses avoid C-corporations. A C-commercial corp’s income is taxed once at the corporate level, and then shareholders who get dividends from the company are taxed twice on their personal tax returns. The only method to avoid double taxation for a C-corp is to reinvest all earnings, except what you take out to pay a fair wage, back into the company.

It’s worth mentioning, though, that while a C-corporation is the most common, you may also choose to establish an S-corporation by filing IRS paperwork. This kind of company is taxed as a pass-through business; however, you’ll be restricted to 100 shares of one class of stock and all of your stockholders must be citizens of the United States. Your tax choices will be more appealing in this manner, but you will be much more restricted if you wish to take on substantial investment from different sources.

An LLC’s owners, on the other hand, may choose whether to tax the LLC as a C-corporation or as a pass-through company. If you opt to be taxed as a C-corporation, your taxes will be the same as if you were a regular C-corporation. You’ll record your share of company revenue on your personal income tax return if you opt to be taxed as a pass-through organization (like with an S-corp). That income will be taxed at your personal income tax rate.

Tax Reform in 2019

The tax consequences for LLCs, companies, and other kinds of enterprises altered beginning with the 2019 tax season (covering the 2018 calendar year). That’s when the Tax Cuts and Jobs Act (TCJA) went into force, often known as the Trump tax plan.

The TCJA reduced the corporate tax rate for C-corporations from a range of 15 percent to 35 percent to a flat 21 percent. The dividend rate remained unaltered, and distributing dividends will still result in double taxation. The owners of pass-through companies will be allowed to deduct 20% of their company income. Limits apply depending on income level and kind of company, but the TCJA will result in tax savings for many LLCs and C-corporations.

LLC vs. C-Corporation Example of a Tax

Let’s suppose you run a retail store that makes $200,000 in earnings this year and you have one business partner with whom you split the profits evenly. If you have a C-corporation, you’ll have to pay the corporate tax rate of 21%, or $42,000, on your earnings. Then, if you took $50,000 in dividends, you’d have to pay a dividend tax rate of 15% on that amount, which in this instance is $7,500. The total tax burden for each couple is $28,500.

Assume you own an LLC that is taxed as a pass-through company. On your personal tax returns, you and your partner would each pay taxes on half of the company income ($100,000). Your tax rate would be 24 percent under the 2018 tax rates, bringing your tax bill to $24,000. In this case, the tax burden for an LLC is somewhat lower than for a corporation.

Governance and paperwork continue to be a problem.

After establishing a company, you should be able to concentrate only on day-to-day activities like marketing and recruiting. However, there are continuing regulatory obligations that you must meet in order to retain your LLC or company. For corporate owners, these restrictions are more onerous.

To be in good standing with the state, corporations must usually accomplish all of the following after formation:

Establish, approve, and enforce company bylaws (and update when necessary).

Elect a board of directors and conduct regular meetings of the board of directors.

Hold shareholder meetings on a regular basis.

Meeting minutes are a great way to keep track of what happened during the meeting.

Stock certificates should be issued.

Keep track of stock transactions.

Shareholders should be informed on a regular basis.

Except for the creation of an LLC operating agreement and the filing of an annual report, none of these formalities are required of LLCs in most states. Maintaining documentation of each member’s equity holdings and holding frequent member meetings is encouraged, but not necessary, to keep your LLC in good standing.

Because LLCs have fewer formality, they typically owe the state less money each year and may get away with lesser accounting and legal costs.

The Differences Between a Limited Liability Company and a Corporation

While LLCs and corporations vary in many respects, they are similar in a few aspects as well. Both kinds of companies are registered business entities, which means they must be formed via the business registration agency in your state. Both have the benefit of limiting the owner’s responsibility.

Business Entities That Have Been Registered

You would not be an LLC or a corporation if you were to establish a company tomorrow. Businesses are either single proprietorships or partnerships by default, depending on how many owners there are.

To start a company, you must first acquire the necessary licenses and permissions. There are a few additional procedures involved in forming an LLC or a company. You must submit your company creation papers with the state’s business filing agency. For a corporation, this is known as incorporation, and for an LLC, it is known as business registration. Only after you submit the proper papers and the state approves it does your company or LLC come into existence.

Protection against Limited Liability

Restricted liability companies (LLCs) and corporations (corporations) both have one major benefit as registered business entities: owners’ liability is limited. Limited liability implies that owners are protected from personal responsibility for the company’s debts and obligations in the usual course of business.

Let’s suppose you’re the owner of a delivery service and a client loses money because you delivered an item late. If you’ve set up your company as an LLC or corporation, the client won’t be able to sue you or go for your personal assets. They can only sue and collect from your company’s assets if they sue you. If you own a single proprietorship or a general partnership, on the other hand, your personal assets are fair game.

As a result, most sole proprietors and freelancers “upgrade” to an LLC or corporation once they start producing consistent income. This provides minimal liability protection. However, limited responsibility cannot be relied upon all of the time. For example, regardless of the kind of business organization you have, if your firm behaves irresponsibly or if you sign a personal guarantee on a loan, you are personally liable.

What Is the Difference Between a Limited Liability Company and a Corporation?

Now that you’ve learned the distinctions between an LLC and a corporation, it’s time to consider how they relate to your company and make a choice. A business attorney or tax expert is the ideal individual to look through your books and financial records and figure out what’s best for your company.

However, there are certain basic considerations to examine while deciding between an LLC and a corporation:

Advantages of a Limited Liability Company

You have the freedom to select how you are taxed (you can avoid double taxation)

Annual costs are typically cheaper for LLCs.

There are less regulatory restrictions.

Advantages of a Corporation

It’ll be easier to obtain money from investors and launch an IPO.

To motivate workers and recruit top talent, you may provide stock options.

Corporations are more known to bankers, courts, and investors.

Disadvantages of a Limited Liability Company (LLC)

Raising funds from investors is becoming more challenging.

Disadvantages of a Corporation

If dividends are distributed, C-corporations face double taxes.

Corporate governance regulations may be time-consuming and costly to implement.

Deborah Sweeney, CEO of business registration firm MyCorporation.com and a Fundera Ledger contributor, believes that determining a company’s development potential is crucial. She declares:

“LLCs and corporations work well in a variety of sectors. Growth is one of the most significant distinctions. For example, if you know you want to keep your business small and independent, you may form an LLC for greater freedom. If you know you want to grow your business and take it global, it’s a better idea to register as a corporation so you may accept money from investors.”

The majority of small company owners we spoke with felt the same way about the LLC vs. corporation decision. LLCs offered simplicity and tax flexibility to business owners, but they needed to be organized like corporations if they wished to receive money from investors.

“I have owned many little companies,” says one of the company owners. From my experience, I’ve discovered that an LLC is considerably simpler to manage in terms of accounting and paperwork. It provides the same level of protection for your personal assets as a company, but without the need to go through all of the bureaucratic hoops. You must pay an annual state fee… I justify the yearly charge based on the value of your time.”

“One of the reasons I selected an LLC over a corporation is because the yearly filing cost for an LLC in my state, New Jersey, is just $50. An S-corporation or a C-corporation, on the other hand, must pay a $500 yearly filing fee. Another factor is because businesses need a more complicated tax return. If you hire an accountant or a tax counselor to prepare your taxes, this will significantly raise your tax filing costs. If you attempt to prepare your taxes on your own, you’re more likely to make a mistake.”

This entrepreneur chose a corporation over an LLC:

“We began out as an LLC. Being an LLC has several advantages, the most important of which is that it is easy. However, when the company developed and outside investment possibilities became limited, we changed to a C-corporation. Being a C-corp and established in Delaware is a necessity if you ever want to interact with outside investors, particularly VCs.”

Creating a Limited Liability Company (LLC) or Corporation

After you’ve decided between an LLC and a corporation, you’ll need to set up your company so you can start servicing clients and earning money. Although setting up an LLC or corporation on your own by contacting your state’s business registration office is the fastest method, most firms prefer a little assistance along the process.

LegalZoom and Rocket Lawyer, for example, will incorporate your company or register your LLC for a fixed cost of $150 or less. You may engage a business attorney to help you set up your LLC or company if you want assistance through every stage of the procedure. A company attorney will explain the advantages and disadvantages of each form of business organization, provide customized advice, and assist you in filing the necessary paperwork.

Final Thoughts

In the end, the decision between an LLC and a corporation is based on your tolerance for paperwork and governance requirements, your tax bill, and your long-term objectives. An LLC’s simplicity and convenience of use are ideal for most small companies. You won’t be subjected to double taxes, and you won’t be required to produce as much paperwork or adhere to as many government regulations. However, if you want to raise venture money in the future, it’s a smart idea to form a company today. It is possible to switch entities later, but it is more costly, therefore it is better to make this choice now and stick to it.