One of the most important decisions that a business owner can make is determining what type of business structure to create. Two common options are corporations and limited liability companies (LLC). According to a recent survey by the National Small Business Association, 42% of businesses in the Untied States are S-corporations and 23% are LLCs. Both of these types of entities provide limited liability for tax debts and liabilities of the business. Liability is generally limited to the owner’s investment in the company. Both types of entities act as a separate being from the individual owner. However, what are the differences between an LLC and a corporation? Additionally, how can you determine which structure to choose? Ferlito Law Group can help describe the differences, advantages, and disadvantages of different business structures, including LLC and corporations. Below, we list the key differences. If you need help choosing the appropriate structure for your business, consider contacting Ferlito Law Group for a confidential consultation.
Business Formation
The differences between an LLC and a corporation begin at inception. To form an LLC, owners must first file articles of organization in the state where they decide to form the business. State law will determine what information needs to be included in these articles of organization. Typically, a lot of information is not required. Instead, the registered information is simply sufficient to serve as notice of the business’ existence to the public. Most of an LLCs governance comes from its operating agreement, which is not filed with the state.
Owners form a corporation by filing articles of incorporation with the state. Again, what must be included in these documents is dictated by state law. Required information may include:
- The business’ name
- The number of authorized shares
- The type of business
- Its registered agent and office
The articles of incorporation may also contain the powers, rights, and authority of the business’ directors and shareholders. If this information is absent, these provisions may not be effective.
Additionally, the corporation must appoint a board of directors that will oversee the business. The board of directors create bylaws for the business.
Owners
The form of ownership of a corporation and LLC is also different. Owners of an LLC are called members. LLCs can be owned by individuals, corporations, a trust, or foreign individuals. The LLC’s operating agreement can indicate how much of the profits members receive. They do not necessarily have to be paid based on the amount of capital they invested in the business. The operating agreement can also state how a member can transfer their membership interest to another member or someone outside the business and what occurs when a member leaves the LLC. If this information is not included in the operating agreement, the LLC has to be dissolved.
In contrast, corporate owners are actually holders of stock, known as shareholders. Shareholders are paid compensation known as dividends in direct proportion to the percentage of the business they own. Shareholders can purchase more stock to own a large percentage of the business. A corporation remains in existence even when an owner leaves the company.
Management
LLCs have a flexible management structure. One or more members may manage the business, or a manager can manage the business. Alternatively, there may be no factual or legal difference between an owner and manager of the LLC. Managers do not have to have formal titles such as CEO or president. Instead, the business can create a management structure that is tailored to their particular needs. There are fewer record-keeping requirements. Some states do not even require LLCs to prepare annual reports.
Corporations have a much more rigid management structure. The corporation must elect a board of directors who are responsible for managing the company and fulfilling their commitments to shareholders. The board hires corporate officers to handle the day-to-day operations of the business. Shareholders elect directors but otherwise do not have control over the daily operation of the business. The shareholders must meet at least once a year. Corporations must make annual reports and must fulfill paperwork requirements.
Profits and Losses
Profits and losses of LLCs and corporations are also much different. Generally, profits and losses are passed through to individual owners based on the information in the operating agreement. Members must specifically identify their share of profits on their personal tax return.
Corporations pay income taxes on its profits or losses on a corporate tax return. The corporation may pay some of the corporation’s profits in the form of dividends while retaining some of the earnings for business operations.
Taxes
One of the most important differences between an LLC and a corporation is how the business (or its owners) is taxed. LLCs pay tax on their net income while corporations pay taxes on their net earnings.
Corporations must pay taxes at the corporate tax rate. Corporation shareholders will pay tax on any dividends they receive. This is sometimes referred to as “double taxation.” This is due to the fact that the corporation must pay taxes on its net earnings and shareholders are also taxed on their financial gain (dividends) from those corporate earnings.
In contrast, LLCs are considered pass-through businesses. Like sole proprietors or partners, the profits and losses of the business pass through to members of the LLC. The members receive a distributive share of profits each year and pay taxes on this share. For example, if a two-member LLC evenly splits a net income of $100,000, each member would be responsible for paying income tax on $50,000 of the net income they received. Additionally, LLC members are considered self-employed, so they are responsible for paying self-employment taxes on their share of the LLC’s profit each tax year.
Ferlito Law Group has extensive experience with corporations and LLCs and can make recommendations based on your business’ particular needs.
Contact an Experienced Business Lawyer for Help Determining Your Business Structure
If you would like help determining whether you should structure your business as an LLC, a corporation, or perhaps some other type of entity, the business lawyers with Ferlito Law Group can help. We can discuss the differences between an LLC and a corporation and give you recommendations about what type of entity structure to use for your business. If you require assistance with forming your business entity, consider contacting Ferlito Law Group.