Corporations’ vs LLC’s: Understanding the Difference
Corporations and limited liability companies (LLCs) are two types of business structures. Both structures exempt their owners from being held personally liable for the debts and other obligations of the company. For instance, creditors cannot seize your home, car, or any other personal assets if you are the owner of a corporation or an LLC that files for bankruptcy. But they have different ownership and management structures, taxation systems, and legal frameworks.
What Is a Corporation?
A corporation, usually referred to as a c-corporation, is a sort of corporate structure that operates independently from the stockholders who own it. The corporation is accountable for debts and wrongdoing, pays its own taxes, and is an independent legal person that can enter into contracts and own property. By purchasing stock in the company, shareholders can become owners. They have a very small influence over how the corporation is run, and they only have to pay taxes on the profit distributions they receive from the business.
What Is an LLC?
A member is a person or group of people who owns an LLC-structured business. Members are often referred to as owners. In contrast to how shareholders are distinct from the corporation, members of LLCs are not. The LLC doesn’t pay taxes on its own. Pass-through taxation, which is when members pay taxes on the LLC’s profits on their personal income taxes, although some LLCs choose different management structures, LLC members can run the business.
What Is an S-Corporation?
An s-corporation, a different kind of corporation, combines some features of LLCs and c-corporations. An s-corporation, like a c-corporation, is a distinct legal entity, and stockholders are only partially liable for the debts and other responsibilities of the company. But just like LLC members, shareholders in an s-corporation are liable for paying taxes on the company’s income.
How Ownership Works in a Corporation and an LLC
A set of bylaws for corporations contains the regulations for ownership, management, and other operations. An operating agreement is used by LLCs to specify roles and ground rules.
The proportion of the company that each shareholder owns in a corporation is determined by the number of shares of stock they own. Let’s imagine a business issues 100 shares of stock, each of which is priced at $10. With a $250 investment, a shareholder would own 25 shares, or 25%, of the business. This shareholder would receive 25% of any distribution of annual profits made to shareholders by the corporation.
Stock is not issued by LLCs. The operational agreement specifies each member’s ownership stake as well as their portion of earnings (or losses). Normally, a member’s share of profits is determined by their ownership stake, but an LLC is allowed to distribute profits differently as long as it complies with IRS “Special Allocations” regulations.
Ownership Is Unrestricted for Corporations But Not LLCs
C-corporation shareholders have the right to freely purchase, sell, or transfer their shares to any third party on the open market.
Only in accordance with the guidelines outlined in the operating agreement may LLC members make investments in the business or sell their holdings (or the rules set by state law when no operating agreement exists). The operating agreement of an LLC may mandate that members sell their shares back to the other members or may grant the other members the right to approve any sale or buyer. In some states, when a member leaves an LLC, it must be dissolved and reformed.
S-Corporations Restrict Certain Types of Ownership
While c-corporations can distribute all of their stock to a small number of shareholders or thousands, to people or other companies anywhere in the world, s-corporations are limited to 100 shareholders, all of whom must be citizens of the United States. Additionally, only individuals are permitted to own stock in s-corporations; corporations, LLCs, and partnerships are not permitted.
How Corporations and LLCs Are Managed
In general, corporations are required to adhere to comprehensive state legislation regarding management procedures. Less governmental regulation applies to how LLCs are run.
How Corporations Are Managed
A board of directors and officers, such as a president and chief financial officer, are essential for corporations. Most states require corporations to file its bylaws with the state, and the bylaws outline the duties and powers of these executives.
The board of directors’ members are in charge of electing the company’s executives as well as monitoring and assessing the company’s course. If, for instance, a corporation’s profits decline or the company posts a loss, a board of directors might become quite active. However, it typically won’t take part in choices like employment, pay, selecting vendors, etc. The company’s officers are in charge of making those daily decisions.
Unless they are also executives, shareholders are rarely involved in the day-to-day management of the company, but they may be asked to vote on issues like electing new board members.
According to the law, corporations must convene yearly shareholder meetings and record the proceedings in minutes. They also must issue annual reports.
How LLC’s Are Managed
An operating agreement is an LLC’s version of a corporation’s bylaws. However, unlike corporations, the majority of LLCs are not required to submit an operating agreement, but some states do mandate that they do so.
LLCs are very flexible in how they choose to run their businesses. They are not required to have a board of directors, company officials, annual meetings, or annual reports in the majority of states. An LLC may be run by all of its members or by a select few of them. Some LLCs also hire a third party manager who has no ownership stake in the business to run it.
Although most states require other annual filings in order for the company to maintain its legal status, only a few states require LLCs to publish annual reports.
How Corporations and LLCs Pay Taxes
Taxes on the company’s profits are paid by the corporation, not the shareholders. However, any dividend payments made to shareholders must be taxed. This tax law, sometimes known as double taxation, is considered by many to be a drawback of the corporate form. In order to reduce their tax liability, corporations are also permitted a number of tax deductions for business expenses.
On the other hand, S-corporations don’t have to pay corporate taxes. The company’s profits are distributed to its stockholders (as is done with an LLC).
In an LLC, all of the company’s gains (and losses) are distributed to the members. Single-member LLCs are treated as sole proprietorships for tax purposes; they file personal income tax returns to report and pay taxes on business profits.
LLCs with several members have the option of paying taxes as either a corporation or a partnership. Members of an LLC who are taxed as a partnership must report their portion of the company’s profits on their personal income tax return.
Members must pay taxes on any distributed profits when an LLC chooses to be treated as a corporation for tax purposes. The LLC is responsible for paying corporate taxes. Profits that are reinvested into the business are not taxed since members are not compelled to pay taxes on retained earnings.
How LLCs and Corporations Are Formed
Both LLCs and corporations are created by submitting the necessary paperwork to the relevant state government, typically the Secretary of State. Articles of incorporation are filed by corporations, and organizational documents are created by LLCs. (In some states, the paperwork may go by a different name.)
The documents typically include the company’s name, address, members’ addresses (in the case of an LLC) or directors’ and officers’ addresses (in the case of a corporation), the nature of the business, and its purpose. The total number of shares of stock that a corporation intends to issue must also be disclosed.
The cost to form a corporation varies by state and occasionally according on how many shares it issues. While Texas charges $300, Arizona allows businesses to incorporate for as little as $60.
Depending on the state, the cost to file articles of incorporation for an LLC might be anywhere from $50 and $100.
Other yearly expenses, such as franchise fees, company license fees, and annual report filing fees are also imposed on corporations and LLCs.
Choosing Between a Corporate and an LLC Structure
Both corporations and LLCs have the benefit of reducing the personal responsibility of the owners. Depending on your demands, you can choose the best entity. Here are some things to think about:
LLCs give greater freedom and require fewer formality. In general, LLCs don’t call for annual reports or meeting requirements. Additionally, they provide a great deal of management flexibility in contrast to companies, which are obligated by law to follow certain formalities such as holding meetings and having a specified management structure.
An LLC typically makes tax compliance easier. Unless the members want to be taxed like companies, LLCs do not pay taxes. On their personal income tax returns, the majority of members must pay taxes on business profits. Because shareholders pay taxes on the profit distributions they receive and the business is taxed on its earnings, corporations are liable to double taxation.
As a corporation, you can draw investors more easily. Investors favor corporations because they can freely purchase stock in the company or sell it on the open market. In order to join or sell your ownership in an LLC, you typically need the consent of the other members, and there may be additional conditions. S-corporations are less advantageous for investors due to ownership requirements as well.
Corporations now have more alternatives for offering perks to employees. Unlike the majority of LLCs, corporations are able to offer benefit plans like stock options. Corporations can also claim tax deductions for a variety of benefit plan expenses, although LLCs can often claim only a percentage of the cost of any benefits they provide.