Both the LLC and corporation are legal entities that provide liability protection for their owners. While the corporation has been around longer, the limited liability company was created to offer the same level of protection. However, an LLC is designed specifically to cater toward the small business owner. It offers the same liability protection as a corporation but allows a much more simple operational structure with a lesser number of formalities.
LLC v. Corporation - TAX MATTERS
The limited liability company offers more tax choices than a corporation. Owners of an LLC can elect for profits to be taxed pursuant to a pass through structure (single layer of taxation) or pursuant to a C corporation (double taxation) or S corporation structure (single taxation but with many requirements and ongoing compliance requirements).
The corporation only has the choice of C corporation or S corporation taxation. Small business owners many times prefer the LLC pass through taxation because it allows them to avoid double taxation of profits and in many cases be able to take business losses to reduce taxes from other income WITHOUT having to worry about meeting a laundry list of S corporation requirements.
While the S corporation structure is available to both types of entities, it only allows a certain # of owners, all owners must be persons (so no entities) and US or permanent residents of the United States. There are other requirements as well so check with your accountant for the specific details.
As a business evolves, things change and with an S corporation tax status, you always need to be on top of the latest S corporation requirements. The failure to meet a requirement, even if accidental, can result in disastrous tax liability and penalties.
The S corporation can have some tax benefits over the standard pass through when it comes to self employment. In these cases, you have the option of S corporation taxation with either the LLC or corporation.
LLC v. Corporation - OWNERSHIP STRUCTURE COMPARISON
An LLC also gives an LLC business much more flexibility when it comes to ownership structure. The LLC laws allow for the company to tailor what each owner gets in terms of voting control and distributions.
The corporation has a set ownership structure. Ownership is defined by a share of stock and each share of stock provides a set right when it comes to voting and profits rights. The LLC can choose this standard structure but does have the flexibility to customize it if needed without having to create multiple classes of ownership.
Accordingly, an LLC is more attractive when it comes to bringing in investment capital or services partners because it offers more options to address specific business situations.
LLC v. Corporation - MANAGEMENT STRUCTURE
In addition, a limited liability company can have a very simple single layer of management (known as member-managed) or the management structure can be structured with a central governing body (manager managed).
When it comes to operations, the LLC is not required to meet the same level of formalities and paperwork as a corporation.
The corporation laws generally impose a set management structure for a corporation which requires a Board of Directors as a central body of management. In addition, in most states, there are required meetings and certain governance documents that must be entered into each year.
While it is still recommended that an LLC have some simple governance paperwork to document major business decisions, it is comforting to know that the laws do not require it for the legal entity to qualify as an LLC and get LLC benefits.
In deciding LLC or corporation, the LLC offers the same management structure imposed upon for a standard corporation but also allows for a much simpler one or a more complex one if needed to protect investors or the business.
Given the simplicity and flexibility of the limited liability company, the LLC was designed to offer all the benefits of a corporation but without the disadvantages. As a result, the number of LLC formations each year greatly surpass incorporations when it comes to small businesses.
However, there are some situations where the corporation may be the better entity choice. If you plan on taking your business public with an initial public offering, you should use a corporation. Also, if your business requires professional company investors such as venture capitalists, the venture capitalists will generally require that your business be a corporation.
As noted above, the decision of LLC or corporation depends on your specific situation and the best person to advise you is a competent attorney after having met with you to discuss your particular circumstances.