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Difference Between Corporation and LLC

Nearly everyone has a general idea on what “Inc.” or “Corp.” at the end of a company name mean. Corporations as legal structures have been around for a long time. To have “incorporated” means that you’ve filed special papers to create a business that is technically a separate entity from yourself. This entity has assets that are separate from your personal assets, can make or lose money separate from your personal savings, and assumes risks (of being sued, for example). The corporation does all these things independently of the person or people who own the corporation, and consequently must also file a special set of tax returns independent from the shareholder’s or shareholders’ personal returns.

Basic Types of Corporations

There are two basic types of corporation: the S Corporation (S Corp) and the C Corporation (C Corp). In most respects they’re identical and differ primarily with respect to the way they’re taxed. It’s a pretty big difference and would probably be the reason you would choose to form an S Corp (which is the form of choice for most independent professionals who incorporate) rather than a C Corp (which is typically the business structure of choice for big companies with lots of shareholders).

Taxation

The money of the C Corp shareholder always gets taxed twice. The C Corp pays its own taxes, then may pay a part of the remainder to you, the shareholder, as dividends. The C Corp pays its own taxes, then may pay a part of the remainder to you, the shareholder, as dividends. You would pay personal income tax on your share of the dividends.

By contrast, the S Corp pays taxes only once – through the individual shareholders. There is no corporate tax return to file. All income is treated as your income, which means that you file a personal tax return and pay personal income tax on the money you derive from your stake in the company, just as in a sole proprietorship. The obvious benefits of this are simplicity and one-time taxation. In case your company loses money one year, you may deduct the amount of your loss on your personal income tax statement. However, there is a flip side: if the S Corp is unable to use its income to pay the shareholders (due to any reason), the shareholders must still pay taxes on their share of the income, even though they never actually received a penny of it.

Corporate ownership

C Corporation has no restrictions on ownership, but S Corporation does. S Corp is restricted to no more than 100 shareholders, and shareholders must be Unites States citizens/residents only. S Corporation cannot be owned by C corporation, other S Corporations, LLCs, partnerships or many trusts. Also, S Corp can have only one class of stock (disregarding voting rights), while C Corp can have multiple classes. Thus, C Corps provide a little more flexibility when starting a business if you plan to grow, expand the ownership or sell your corporation.

C Corporation and LLC – What’s in Common?

Ownership. Being essentially part corporation, part sole proprietorship, in the eyes of the law the LLC, like a corporation, is viewed as a person – a legal entity independent of its owners. This means that it can enter into contracts, buy and sell products and services, make and lose money, sue and be sued.

Liability Protection

Just like a corporation, a limited liability company’s owners have a high degree of protection from financial loss beyond what they have invested in the company. They have limited personal liability. Any lawsuit or bankruptcy proceeding involving the company is regarded by the courts as concerning only the company, not the individual owners, unless the court believes the owner has committed fraud or other illegal act, or has failed to establish a clear division of the company from his or her personal finances.

No Double Taxes

Like the S Corp, the LLC itself does not pay taxes; its members do, on their share of the income. The LLC’s income is passed along to the members, who report their share of the income on their personal tax returns.
State Legislation. Another similarity between S Corporation and LLC (actually, between any kind of corporation and LLC) is that both are creatures of state law. The rules which define an them are established by state legislation, so there are variations from state to state. LLCs, like corporations, can be formed in a state other than the one in which it does business. In most states, the articles are filed with a division of the Secretary of State’s office (the same as for corporations).

So What Is Different Here?

Performance Flexibility. LLCs have more flexibility and fewer restrictions than S Corps. An S Corporation cannot have more than 100 stockholders, cannot issue more than one class of shares, and is subject to more formalities than an LLC. Corporate stockholders are not required to pay Social Security and Medicare taxes on profits over and above the stockholders’ salaries, while owners of an LLC are required to pay these taxes on profits.

Ownership distribution

A corporation’s ownership is determined by how many shares of its stock a person owns, and dividends are distributed on a “per share” basis. An LLC, on the other hand, can set a special allocation of distribution of profits for a member that is different than that member’s ownership share. This must be specified in its operating agreement.Many states require LLCs to have at least two members. You can’t have a one-person LLC. (And in most states, a member of an LLC can’t sell his interest in the company unless the other members unanimously approve of the transaction.)

Taxation

Taxation is undoubtedly why most LLCs are formed. Instead of being taxed, like most corporations, as a separate entity, an LLC is taxed like a partnership or sole proprietor business. The LLC files an annual tax return, but its tax liabilities are passed through to its members (an LLC’s member is the equivalent of a corporation’s shareholder.) The members then pay taxes according to their individual tax rates. This allows to avoid the double taxation where the corporation’s profits are taxed as corporate profits and again as a shareholder’s income when they receive the profits as dividends.

Wages

An active member of an LLC cannot be paid wages. Any money paid to that member is regarded as a withdrawal of profits from the company and is subject to self-employment taxes. Inactive members, who have been given a membership share because of money invested or other consideration, do not have this problem. Money that is distributed to them is treated as unearned income. An S Corporation has a self-employment tax advantage because an active owner can also be an employee.
Shares. Unlike an S Corporation that may have no more than 100 shareholders, an LLC may have an unlimited number of members (Owners of an LLC are known as members.) S Corporations have the ability to issue stock when capital needs to arise. Issuing stock is not an option enjoyed by an LLC business structure.

Management

The rules for how an LLC’s management can be organized are less stringent than for a corporation. Most LLCs are managed by one or more of its members, though it is possible to hire outside managers to run the business. An LLC must file an annual report, but is not required to hold an annual meeting. The details of the LLC’s management structure are defined in its articles of organization when it is formed.
“Continuity of life”. One more difference between an LLC and a corporation is the length of existence. A corporation is an enduring business structure with an unlimited life. Owners and directors of a corporation may change without interrupting the business activities. On the contrary, an LLC may automatically end if a member dies, retires or decides to sell his ownership portion of the business. It can set a date when the LLC is automatically dissolved, or it can specify that the LLC is to dissolve upon the incapacitation or retirement of one of its members. In both these instances, however, the dissolution of the LLC is indeed not final, for the remaining members can vote to continue the business.

To sum up, it can be said that an LLC is a hybrid of a corporation and a partnership/sole ownership business, with the limited liability and some, though not all, of the extra reporting requirements of the former, and the pass through income tax benefits and flexibility of management of the latter. You may need professional advice in choosing the best entity for your business.