When you launch any kind of new business, one of the most foundational decisions you’ll make is which legal structure to employ. This choice affects everything from how you manage daily operations to how you file your taxes. It’s no exaggeration to say that this decision can be make-or-break for your business.
Most business owners start off as Sole Proprietors, an option that provides a lot of flexibility and minimal regulatory oversight. Sooner or later, whether it’s to bring on employees or to procure business financing, it may become necessary to upgrade to either an LLC or a Corporation.
Both are viable options, but before making a decision, it’s critical to understand their respective pros and cons.
What are the Differences Between an LLC and a Corporation?
These two structures allow you an option to formalize your business, establishing it as its own unique legal entity. And, both allow some built-in liability protections to help shield your assets from lawsuits and from creditors, which is one of the primary benefits that entrepreneurs should expect. Beyond that, there are a number of important distinctions.
Ownership
One distinction pertains to ownership. The LLC is owned by its members, each of whom own a certain percentage of the company. It’s possible to have a single-member LLC, but it’s also quite common to have a multi-member LLC.
By contrast, Corporations are owned by shareholders, people who have actually invested money in the business. When you start a Corporation, you will be required to issue shares, which means you will not be able to maintain full control of the business (though you may be able to maintain a majority of it).
Formation
Forming an LLC is pretty simple. You’ll need to file a document known as the Articles of Organization with your state, which will usually entail paying a small fee, as well. LLCs are also required to choose a Registered Agent, either an individual or an organization that can receive legal correspondence on the business’ behalf. Note that the Registered Agent must have a physical mailing address in the state of registry; so, an LLC registered in the Lone Star State will need a Texas Registered Agent.
Forming a Corporation requires you to follow similar steps, as well as some added ones. These include creating and adopting bylaws, electing a Board of Directors, and issuing shares. Compared to forming an LLC, forming a Corporation is more complicated and more expensive.
Management
LLCs offer a lot of flexibility with respect to how you manage day-to-day operations. You can choose to have a member-managed LLC, or outsource to a third-party management company, whichever is better-suited to your skills and business goals.
In a Corporation, the Board of Directors is in charge of running things, though they will usually delegate specific officers for individual tasks. The Board must also hold annual reports and issue regular reports to shareholders, briefing them on how the business is being run and on how it is performing.
Taxation
Taxation is a major point of distinction here.
Corporations are taxed on a corporate basis by default, which means businesses must pay taxes and then shareholders must pay additional taxes on their share of the profits. This is often known as “double taxation.”
When you have an LLC, the default position is pass-through taxation. What this means is, there are no corporate tax returns filed. Members simply declare their share of the profits (or losses) on their individual tax returns, then pay taxes accordingly. This allows them to avoid double taxation.
In select situations, the LLC’s members may decide it is more advantageous to opt into corporate tax status. They always have that option!
Also note that, occasionally, stand-alone LLC-specific taxes might be levied; currently, California is the only state to have an LLC tax, which is a flat rate of $800 annually.
Choosing Between an LLC and a Corporation
There is no one-size-fits-all solution here, and different businesses may reach different conclusions about the structure that’s right for them.
Generally speaking, an LLC might make more sense if you:
- Wish to avoid corporate taxation.
- Desire the more flexible option, with the lightest regulatory burden.
- Don’t plan to fundraise with investors.
Whereas a Corporation might prove more sensible if you:
- Wish to attract investors and sell ownership in the company.
- Hope to go public at some point in the future.
As you consider these two options, you may wish to seek additional insight from a trained expert. Either a business attorney or a business coach should be able to provide information about the legal structure that’s best for your company.
Above all, remember that this decision can be hugely impactful for the future of your business, making it crucial to size up both options wisely and astutely.
Author Bio
Amanda E. Clark is a contributing writer to LLC University. She has appeared as a subject matter expert on panels about content and social media marketing.
