Limited liability companies (LLCs) and corporations are two common structures for a small business. They both provide personal liability protections. But an LLC differs from a corporation in ownership structure, management and taxes. 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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The word corporation can refer to multiple business structures, including C corps and S corps as well as nonprofit corporations. Because C corporations are the default legal entity, the general use of “corporation” often refers to this structure. Corporation vs. LLC: Quick-decision guide
Here are a few quick tips to help you decide whether a corporation or an LLC is the right structure for your business.
| Choose an LLC if you… | Choose a corporation if you… |
|---|---|
| Want to avoid corporate taxation. | Intend to sell ownership. |
| Don’t plan to fundraise with investors. | Want to attract investors. |
| Prefer fewer management formalities and annual requirements. | Plan to 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.
Differences between an LLC and a corporation
LLCs and corporations both require a business owner to file formation documents with the state. Both structures also provide their owners with limited liability protection. This means owners aren’t personally liable in the event of bankruptcy or lawsuits.
The two structures diverge in several ways, though. 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. Members may include individuals, corporations, other LLCs and foreign entities (although this may vary by state).
Corporations 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 legal documents called articles of organization with your Secretary of State. These contain basic details about your LLC, including its name, address and member information.
It's also wise to create an LLC operating agreement. This is required in only a handful of states, but it's useful regardless. The operating agreement outlines management of the LLC and details about membership interest.
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 file articles of incorporation with your Secretary of State. These, too, contain basic information about your business. After you file with the state, you need to complete a series of tasks that aren’t required for LLCs, including:
- Create and adopt corporate bylaws.
- Elect a board of directors.
- Issue stock to shareholders.
Unlike LLCs, it’s relatively easy to transfer shares within a corporation. Plus, the business can survive even if a shareholder leaves. For this reason, professional investors prefer to work with corporations.
» MORE: How to incorporate a business
Management and ongoing requirements
Corporations must meet pretty strict management and ongoing requirements. But LLCs have more flexibility.
A corporation’s elected board of directors manages the company at a high level. The board appoints officers to run day-to-day operations. Corporations must meet a number of ongoing requirements, including:
- Hold annual shareholder meetings.
- Record stock issues and transfers.
- File annual reports.
- Maintain corporate records.
LLCs, on the other hand, have two management options:
- Members manage the business (called a member-managed LLC).
- Members elect managers to run the business.
Most, but not all, states require LLCs to file annual reports. 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. Meaning, owners only pay tax once and at their personal income tax rate. 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.
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.
