What is the Difference Between an LLC and a Corporation?
Each year, more than 600,000 businesses are opened. Among all the new companies, the majority are LLCs, taking up around 33 percent and following S-corporations, and corporations closely in that order.
Potential business people are sometimes torn between establishing a limited liability company (LLC) or a corporation. Both entities have their advantages, but a decision has to be made.
Before making this bold decision, it is crucial to understand what is the difference between an LLC and a corporation. After that, you can weigh your options and decide accordingly.
However, it’s necessary to note that limited liability protects your assets. Any debts accrued by the business cannot be repaid using your assets since your obligation is only restricted to what you have invested in the company.
What Is the Difference Between an LLC and a Corporation?
While distinguishing between the two, we can use various considerations. Here are some of them.
1. Taxes
LLC Taxes
An LLC entity is considered a pass-through entity during taxation. Therefore, all profits are passed through to the members. Once they have been passed through, taxation is now carried out on an individual level.
Since taxing is on a personal level, it makes the entire filing process more straightforward. Any losses or running costs are also deducted from individual tax returns.
LLC tax rates are based on the individual’s total income — as it would happen to a sole proprietor. The members might also be subjected to self-employment tax. In some states, LLC might be required to pat franchise tax annually. However, there is no standard rate for franchise tax, and it varies from state to state.
Notably, LLC entrepreneurs can choose to be taxed as a corporation or a C corporation.
Corporation Taxing
As opposed to LLCs, a corporation is treated as a separate legal entity. Corporations have to pay taxes on their profits and dividends. The tax paid for the gains is referred to as a corporate tax.
Dividends go through double taxation since, unlike salaries, they are not tax-deductible. One might be quick to oppose the idea of double taxation. However, the additional tax responsibility can be offset by federal deductions. These deductions are a reserve for corporations.
As of 2018, corporations were expected to pay a 21% tax on their profits, which is quite lower compared to individual taxes. If a corporation chooses to keep any income, the retained income will only be taxed once at the 21% rate. Corporations can take advantage of that policy by investing profits back into the business.
If a corporation has less than 100 shareholders, it is at liberty to file an S Corporation election, which allows them to be treated like a pass-through business.
2. Business Ownership
When considering how to start a brokerage firm or starting any such business, it is essential to understand the ownership structure of the entity you choose to avoid conflicts in the future.
A limited liability company can distribute its ownership stake regardless of their financial contribution to the company. Therefore, the profits can be shared equally among stakeholders.
An LLC can also be owned by foreign people or by other corporations. The operating agreement clearly states how membership can be transferred between the members.
It also says what happens in case a member withdraws from the LLC. If the agreement does not state what happens, it leads to the LLC being dissolved in case of the departure of a member.
On the other hand, a corporation can sell percentages of its shares of stock to shareholders. These shareholders can transfer shares, buy more, or sell some off at will.
If you want to start a business that attracts outside investors, a corporation could be the best option. A corporation has perpetual existence. Therefore, it continues to exist even if one of the shareholders withdraws.
3. Management
An LLC is quite flexible in terms of management. It can either be managed by the members, or they can choose to get managers. Any member of the entity can serve as the company’s manager. In the case of a manager-managed LLC, the members do not play an active role in running the business.
A corporate, on the other hand is not flexible. It is a requirement to have a board of directors to run the corporation. The shareholders only have the mandate to approve significant decisions in the corporation.
The shareholders can elect directors, and any shareholder can be chosen as a director or an officer. There is a set of corporate bylaws which are adopted soon after the corporation has been formed.
4. Formal Requirements
A corporate’s shareholders are required to hold a meeting annually. In the meeting, corporate minutes must be documented. Also, every corporation is required to document an annual report.
LLCs have fewer formal requirements. For instance, minutes are not a requirement. LLCs don’t have to hold annual meetings, unlike corporations.
In some states, LLCs are required to file reports annually. Find out what your state requires for full compliance.
5. Legal Protection
Although both entities provide legal protection to their owners, there is a difference. Since corporations have been in existence for long, they show uniformity in the laws across all states.
On the other hand, LLCs being relatively new, they have varying rules from state to state. Their laws are a blend of both corporate and partnership laws, creating a grey area.
Due to the variation in laws from state to state, some businesses might choose to exist as an LLC in one state and a corporation in the other.
How to Choose Between an LLC and a Corporation
Having known what is the difference between an LLC and a corporation, it is now time to make a move. To decide, clearly outline the goals of your business — then compare and see which entity aligns with these objectives.
If you can’t decide on your own, you can consult a qualified CPA or attorney for advice. You can get all your doubts cleared as well as get guidance for the entire process. Check us out for unlimited access to tools that will help propel your business to the next level.
