LLC vs. Corporation: Which is best for your business?

When you start a new business, one of the first questions that comes up is your business structure. Two of the most common types of business structures are LLCs and corporations. While many small businesses start out as LLCs, there are some situations where a corporation can make sense — either at formation or further down the line. 

Today, we’ll run through the pros and cons of each business structure and look at industries and financial situations that may play a role in your decision. Ultimately, these decisions are best made with the guidance of a small business attorney and CPA who have reviewed your financial situation and business plan, but educating yourself before going into those meetings will help you know which questions you want to ask. 

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What is an LLC?

LLC stands for limited liability company. An LLC protects your personal assets from creditors and lawsuits that come after your business, limiting your liability. There are certain things you can do to burst your liability protection, like mixing personal and business bank accounts or assets. 

An LLC is run by members — or owners. There is no board of directors required, but you can have one if you wish to structure your business that way. When you file your taxes as an LLC, you are able to claim the income on your personal tax returns rather than worrying about corporate taxation. 

LLC pros

• Limited liability protection. 
• Less paperwork and legal oversight than a corporation.
• Taxed as a pass-through entity without the threat of double taxation.

LLC cons

• Liability is limited, which is better than a sole proprietorship but doesn’t provide the same level of liability protection as a C corp.
• Owners are responsible for both the employer and employee portion of FICA taxes. 
• Can have investors but cannot issue stock. 

What is a corporation?

There are many different types of corporations. Most commonly, we think of C corps, but a corporation can also be a: 

• S corp: This structure can be used in two different ways. It can be used by a corporation to pass its revenue to its shareholders, allowing them to avoid double taxation. It can also be used as a tax election by an LLC to help the owners reduce their FICA tax burden. 
• Nonprofits: Board members can’t benefit monetarily from the organization. If you want the entire organization to be tax-exempt, you’ll have to take an extra step and file for tax-exempt status for your existing nonprofit corporation with the IRS. 
• Professional corporation (PC): Common for professions involving law, medicine and engineering. Provides liability protection for each board member when other board members encounter negligence or malpractice liability issues, but does not provide protection when you yourself encounter these same problems. 
• Close corporation: This is also sometimes known as a closely held corporation and is only available in some states. The number of shareholders is usually limited to about 30 or 50, and shareholders are usually more actively involved in day-to-day operations. Depending on state law, may have less regulatory oversight and formality requirements when compared to a traditional C corp. 
• B corporation: Short for benefit corporation. Available in most states. Indicates the corporation serves a social or environmental greater good. This ‘greater good’ must be demonstrated according to set accountability and transparency standards. 

Corporation pros

• C corp: Increased liability protection over an LLC. Owners can deduct a greater array of personal medical expenses, and it’s the easiest structure to attract investors.
• S corp: Allows shareholders to avoid double taxation or cut FICA taxes.
• Nonprofits: If you seek 501(c) status, the organization can be exempt from taxes. Donations made to the corporation may also be tax-deductible for donors.
• Professional corporation: Shields you from negligence or malpractice suits brought against your fellow board members. 
• Close corporation: Usually requires less regulation and oversight, which could lower expenses. Shareholders can participate in day-to-day activities. 
• B corporation: Ability to attract investors or run marketing campaigns based on the “greater good” your company serves. 

Corporation cons

• C corp: Subject to double taxation. 
• S corp: Limited number of investors, and all investors must be domestic.
• Nonprofits: Owners or board members cannot profit from the business. Any profit must be reinvested in the nonprofit organization.
• Professional corporation: No liability protection if you individually face a negligence or malpractice suit. 
• Close corporation: Number of shareholders limited — usually to a maximum of 30 or 50. Might have transfer restrictions on stock certificates depending on the state. 
• B corporation: Extra transparency and accountability requirements without any real tax or legal benefits over a C corp. 

What do an LLC and a corporation have in common?

“Both corporations and LLCs are distinct legal entities, separate from their owners,” said Laura Norris, Director of the Entrepreneurs’ Law Clinic at Santa Clara University. 

“The owners of LLCs and corporations enjoy limited liability for debts and other liabilities of

the company. Both of these legal forms require formalities such as registering

the entity with the appropriate jurisdiction, continuing to maintain the registration and

paying appropriate fees.”

Common fees and registration requirements for both LLCs and corporations include: 

• Registration of articles of organization or incorporation with the secretary of state. 
• Securing a registered agent.
• Apply for an employer identification number (EIN) with the IRS. 
• Register with state labor and tax authorities.
• Get relevant business licenses and permits.
• File annual reports with your secretary of state’s office.

What are the key differences between an LLC and a corporation?

There are two key factors that differentiate an LLC and a corporation. Most of it comes down to organizational structure and taxation. 

History and organizational structure

“You can trace the history of corporations back to an Act of Parliament in Holland in the 1600s,” said Jim Cunningham, partner at Cunningham Legal in California. “It gave companies structure. Incorporating a company makes it a legal entity that exists by itself. It has formalities and by-laws. Whereas an LLC just needs to have members without all the extra structural requirements.”

LLCs first started popping up in the 1970s, but they didn’t start gaining steam until the 1990s. Much of their popularity can be attributed to the tax advantages they provide over C corps.

LLC vs Corporation: Differences in taxation

C corps must pay taxes before distributing dividends to shareholders, and then the shareholders must pay taxes on those dividends on their personal tax returns. With an LLC, everything is pass-through, so the owner(s) only pay personal income taxes on profits. No double taxation is required.

Either an LLC or a corporation can elect to be taxed as an S corp, which is a pass-through entity. This allows corporations to avoid double taxation and LLC owners to reduce a portion of their FICA taxes. S corps have disadvantages, too, like limiting the number and nationality of investors in a way that C corps and LLCs don’t. 

Which is best for your business?

Deciding whether you should form an LLC or corporation is entirely dependent on your business’s situation. Bear in mind that just because you start out as one doesn’t mean you can’t switch to the other — it’ll require some paperwork, but your decision doesn’t have to be permanent. 

When should you choose an LLC?

“Most small businesses benefit from an LLC because there’s less corporate formality,” said Cunningham. “Corporations must have annual meetings — those meetings usually involve lawyers, which increases the cost. With an LLC, really, the only thing you’re going to need is a schedule of members.”

Cunningham also notes that LLCs are preferential in some industries, like real estate. On top of tax advantages, a company may establish many LLCs in different states to take advantage of each state’s differing limited liability definition. This is an advanced strategy that should only be done with appropriate legal counsel.

When should you choose a corporation?

“Recommending a type of business entity requires a keen understanding of a particular company’s business plan and the circumstances of its owners, so I don’t have a one-size-fits-all sort of recommendation as to when a corporation is preferable over an LLC,” said Norris.

“However, one of the benefits of a corporate form is that it has been around for a very long time. Investors, shareholders, employees, partners and customers are sometimes more comfortable transacting with a corporation as opposed to an LLC.”

Norris notes that you do have the option to start out as an LLC, and then convert to a corporate business structure at a later date if you find this is a sticking point for potential investors. 

Featured LLC service offers

ZenBusiness

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