Let me start by saying that there is no “one size fits all” business entity for your business. The two most common options are LLC’s (aka Limited Liability Companies) and Corporations.
So which entity is a better choice for your business? An LLC or a Corporation?
In this article, we are going to discuss the advantages and disadvantages to forming an LLC vs. forming a Corporation, and then we will talk about which entity might be right for different types of businesses.
Caveat – For purposes of this article we will be talking about the C-Corporation primarily. The S-Corporation is a tax election that is filed with the IRS and can apply to both corporations and LLC’s. Confused? You should talk to your accountant or a tax lawyer…
LLC vs Corporation – The Similarities
Here are some common similarities you need to know about when choosing between an LLC vs a Corporation.
Separate Business Entities: Both the LLC and the Corporation are business entities that are separate and distinct from you as the business owner.
Formation: Both Corporations and LLC’s are formed by submitting paperwork and paying a filing fee in the state where you do business. Except for in some very extraordinary circumstances, the state where you live and work is the state where you will want to form your business entity. If you are forming an LLC, you will file Articles of Organization, and if you are forming a corporation, you will file Articles of Incorporation.
Limited Liability: Both LLC’s and Corporations offer limited liability protection to you as the business owner.
Ongoing Requirements: Both are required to make annual filings and pay annual fees to the state where they were formed. Failure to pay these fees or make these filings can cause expensive penalties or even result in the administrative dissolution of your business.
Differences between LLC’s and Corporations
There are a number of differences between LLC’s and Corporations as well. Here are just a few:
Ownership: Both LLC’s and Corporations can have an unlimited number of owners. (S-Corps are limited to 100 owners). The owners of LLC’s are called members and the owners of Corporations are called stockholders or shareholders.
One major benefit to LLC’s is the ability to distribute profit to members without regard to their initial capital contribution. Corporations can do this by issuing different classes of stock, but this gets legally complicated and expensive. S-Corporations do not have the ability to do this.
US Residency: Non-US Residents or Citizens are permitted to own LLC’s and Corporations in the United States. However, you must be a US Resident or Citizen to own an S-Corporation. Click here for what we recommend for non-US Citizens/Residents.
Ongoing Formalities: Corporations, in general, are subject to more rigid and strict corporate formalities. They must adopt bylaws, issue stock, hold annual shareholder meetings, keep meeting minutes, and maintain corporate records.
LLC’s, on the other hand, are much more flexible. The only requirement that is highly recommended is that an LLC have an operating agreement in place and that the members of the LLC follow that agreement. We also recommend, to maintain limited liability protection, that the LLC hold and document annual meetings and document all major decisions of the company.
Charging Order Protection: A major advantage to LLC’s is that they afford the owner a level of asset protection that corporations do not. If you have personal debts (i.e. a lawsuit against you, credit card debt, etc.), then the judgment creditor may or may not be able to foreclose on your business if you are an LLC (it will depend on the laws of your state).
However, if you are the stockholder in a corporation, and the judgment creditor comes after you, they can seize your shares in the corporation and then vote to dissolve the corporation to satisfy the judgment.
I realize this gets legally complicated. What you need to know is that an LLC may be protected from a judgment creditor, while a corporation will not.
Tax Treatment: An LLC can elect to be taxed as an S-Corporation, meaning that the members must pay themselves a “reasonable salary” and distribute the profits of the LLC to the members each year. If the owner of an LLC does not elect S-Corp tax treatment, then the members may take distributions whenever they like, and the income from the LLC flows through to the member’s personal tax return and is subject to self-employment taxes at a rate of 15.3% up to $118,500 (for the tax year 2017).
A corporation, on the other hand, will file and pay its own taxes. The stockholders of the corporation will receive a salary, and any profits may be (but do not have to be) distributed as dividends. The owner will pay tax on the dividends in the tax year that they are distributed. This is why corporations are said to have “double taxation”.
Investment Capital: While it is true that LLC’s can issue “membership interests” as a way to attract an investor in the business, this is uncommon and complicated. Corporations, on the other hand, can issue stock to lure investors of the business.
LLC or a Corporation? What’s the Bottom Line?
Who is an LLC right for? An LLC is right for a business that is just getting started with a few owners, who are all US residents/citizens and don’t want the complications that come from forming a corporation. You don’t need to elect S-Corp tax status immediately, you can do that after the LLC is netting over $50,000 per year to each owner.
Who is a Corporation right for? If you are seeking investor capital and are interested in major growth, or you are a not a US Resident or Citizen, then a Corporation might be right for you.