Deciding between a Corporation and an LLC often comes down to small details when a new small business owner is building a new business. Choosing the right entity for your business means taking a long look at all the considerations.

It is always best to seek the advice of an experienced small business lawyer, consultant, or accountant before you start (and our small business legal subscription plans are the perfect, in-budget solution for small business startups!), but here is a brief overview of the differences between a Corporation and an LLC.

Legal Entity VS Tax Entity

There is a difference between a Legal Entity (an LLC or Corporation) and a Tax Entity (C-Corps and S-Corps VS Sole Proprietorship/Partnership). A tax entity is how the IRS (and some state tax boards) classifies the business. The legal entity is how the courts, the state, and partners view the business. For instance, a corporation (the legal entity) gets a C-Corp or S-Corp tax designation and a tax entity; however, an LLC (the legal entity) gets to decide how it is classified: as a sole proprietorship/partnership or C-Corp for tax purposes, as there is no LLC tax entity. LLCs are then designated, for tax purposes, one of the other tax identities, typically, the tax type that has the most benefits for the business.

Speaking of Taxes...

LLCs have flexibility with their tax designation that corporations don't. A disadvantage of the corporation tax designation is the "double taxation" implication. Corporations' profits are taxed (corporate tax), and then shareholders are taxed on their dividends (individual tax). S-Corp designations allow for flow-through taxation (eliminating the corporate tax), but there are requirements to qualify for this designation, and some requirements may not be ideal for some businesses. Some businesses may have no choice except the C-Corp tax designation and accept the double taxation.

An LLC, regardless of organization and structure, chooses how it wants to be taxed. An LLC is treated like a "pass through" corporation by default (single taxation), but it can choose to be treated like a C-Corp or an S-Corp if it qualifies. While choosing double taxation may seem counter intuitive, but it does make sense in some situations, though this is rarely the case.

The taxation differences between an LLC and an S-Corp are more nuanced, as both offer pass through taxation (no double tax), but the LLC's distribution of profits are then subject to employment taxes, while an S-Corp's dividends are not. Careful planning means that some businesses can avoid the employment taxes by becoming an S-Corp. However, S-Corps require a lot more paperwork which may deter some businesses from choosing this entity type. As always, new business owners should consult with a small business professional - such as an attorney or a consultant - before making this choice for their new business.

Business Ownership

Shareholders are the owners of a corporation, while the owners of an LLC are members, and there are other differences besides just the names. LLCs can distribute their stakes in ownership regardless of the amount of capital a member has put into the business. A C-Corp can achieve the same result by creating a stock class structure while an S-Corp must have a single class of stocks with dividends distributed proportionally to the amount of capital put in by each shareholder. Creating unique classes of stocks means agreeing to the double taxation.

The management structure of an LLC is usually centralized, meaning that any member can act as a manager and the LLC can choose to have no distinction between the LLC owner and the manager. A corporation must have a Board of Directors to handle management responsibilities and corporate officers running the day-to-day operations. Shareholders are considered owners as a class, but are separated from business decisions except to approve major corporate decisions and to elect directors. Individual shareholders may be elected to be directors or appointed to be officers.

Legal Considerations

The corporation designation has been in existence for hundreds of years, meaning that, as the form has matured, the laws for corporations are virtually uniform. Centuries of case law precedent exist to resolve disputes involving corporations, and financial experts can comfortably guide a corporation knowing how the laws will work.

LLCs are relatively new. LLCs began to be recognized in the 1970s, and with characteristics of both corporations and sole proprietorships/partnerships, an LLC is a "newer" type of legal entity. These dual characteristics mean that states may have different laws and regulations in how LLCs are treated.

Though there can be some similarities to how LLCs are treated state-to-state, there are enough differences that some businesses even choose to be an LLC in one state but a corporation in another. Eventually, laws governing LLCs in the United States should become more uniform, but for now, these discrepancies can be enough to be the deciding factor when a new business owner is structuring their new enterprise.

Helping new business owners understand the legal and tax implications of their new business entity is why I started my business consulting firm. I have helped dozens of businesses through the research, documentation, and filing of forms for small businesses and look forward to helping you and your small business, too!

If you want to start getting the paperwork for your startup handled quickly, easily, and conveniently so you can focus on your business, call (208) 755-8335 or email me at debbie@debbieaferguson.com for an appointment today!