What is the Difference Between a Corporation and an LLC?

Although corporations and LLCs are similar, they have some critical differences. Choosing the right entity can mean a significant difference in tax treatment, for example. The membership structure is comparable, but there may be some restrictions that apply to corporations that do not apply to LLCs, and vice versa. Learning about the major differences between these two business structures is vital to choosing the right business structure for your company. Of course, getting the help and advice of an experienced business attorney can always help.

Formation

Creating these two entities is very similar, but the terminology and documentation are slightly different. When you start your corporation, you must file “Articles of Incorporation” with the state. A limited liability company (LLC), on the other hand, uses “Articles of Organization.” These documents have different requirements to be valid. 

You will also generally need an“Operating Agreement” for an LLC as well. In a corporation, you will likely need to create bylaws, which function similarly.

Tax Treatment

Perhaps the most important difference between the two entities is how they are treated from a tax perspective. Unless the business owners inform the IRS of their election to do otherwise, a single-member LLC is taxed as though a sole proprietorship (using Schedule C) and a multi-member LLC is taxed as though a partnership (using Form 1065). As such, an LLC is a “pass-through” entity meaning that it does not owe income tax but instead passes the tax liability through to the company’s owners. All of the earnings and losses are captured on the owners’ or members’ tax personal tax returns using a Schedule C for single-member LLCs and a K-1 for multi-member LLCs. That means that whatever the owner’s personal tax rate is will be the rate of taxation for the LLC. Using an LLC instead of a corporation definitely makes tax-time much easier.

A corporation is a separate unit for tax purposes. It must fill out its own tax return, and the corporation pays its own income taxes. The owners are taxed on the dividend income that they receive from the corporation. This “double taxation” can be a huge negative for many business owners, particularly smaller companies. However, in some circumstances, an LLC can benefit by electing to be taxed as a corporation.

Ownership and Management

“Shareholders” own a corporation. Those owners can be individuals, or they can be businesses. The business will issue stock to show ownership. A corporation can have several classes of stock as well. Each type can have different rights when it comes to ownership of the company and dividends received. There may be maximum numbers of stocks that you can have in some circumstances as well. Corporations are managed by a Board of Directors.

An LLC is owned by “Members.” A member can also be either an individual or a company. Some LLCs do have membership certificates, which are similar to stock certificates, but they are not technically required. Instead of having classes, each member can have different rights depending on what is set out in the Operating Agreement. An LLC can be managed by either all of the members, some of the members, or one individual manager that need not be a member. Any of these management structures are allowed as long as the Operating Agreement permits it.

Ongoing Maintenance

Corporations require annual reporting to continue their corporate status. Filing those reports also means that you have to pay filing fees as well. Corporations also have to hold at least annual meetings. In contrast, an LLC may not be required to file an annual report, but the LLC likely will be required to pay a yearly fee.

Choosing between these similar options can be daunting if you are forming a business for the first time. If you are just starting out or you are considering switching from one entity to the other, you need a knowledgeable guide to help you through the process. Business formation and transaction attorney Steve Thienel is dedicated to assisting clients in Maryland and throughout the DC Metro area. Contact Thienel Law, LLC today for assistance with your business needs.