Many entrepreneurs wonder if an LLC is a corporation. An LLC is not the same thing as a corporation, but it’s easy to get the two business entity types confused. In this article, I’ll explain the difference and highlight some of the advantages these structures have over unregistered entities.
Limited Liability Companies and corporations are both types of statutory (state-registered) entities. To create them, business owners must file formation paperwork with the state and pay a registration fee. There may be other tasks as well that state law requires to legally form an LLC or establish a corporation. The exact requirements vary from state to state.
Entity Overview
Today we’ll touch on three types of business entities that include:
- C Corporation – The Corporation is a legal entity separate from its owners, and it provides a significant degree of personal liability protection for its owners (shareholders). Ownership is through holding stock in the company, which may be held privately or publicly.
- Limited Liability Company – The LLC structure combines the advantages of a C Corporation and those of a Partnership or Sole Proprietorship. It can be a single-member LLC or a multiple-member LLC. Forming your business as an LLC limits member (owner) liability while requiring less paperwork and fewer formalities than a corporation.
- S Corporation – The S Corporation is a subtype of the corporation structure. It allows a C Corporation to elect to be taxed as a Partnership, with all business income taxed at the owner (shareholder) level at the tax rate for individuals.
Ownership
An LLC’s owners are called “members,” and a corporation’s owners are called “shareholders.” Both entity types may have as many owners as they want. An exception is if they elect to be taxed as an S Corporation, which may have a maximum of 100 owners.
Individuals, other LLCs, corporations, or foreign entities may own a Limited Liability Company. However, some states don’t allow certain professions (such as lawyers, doctors, and accountants) to form an LLC. Usually, those states provide the option of forming a PLLC (Professional Limited Liability Company) instead. An LLC’s members’ roles, responsibilities, ownership percentage, and percentage of profits and losses should be laid out in the company’s LLC operating agreement.
C Corporations have virtually no restrictions on who can own them — individuals, other business entities, and even non-resident foreign individuals may be shareholders.
However, the IRS does restrict who can be a shareholder in an S Corporation. S Corporations may not be owned by C Corporations, other S Corporations (in most situations), LLCs, partnerships, and most trusts.
Owners’ Liability
Both the LLC and corporation structures, which are separate legal entities from their owners, limit owners’ personal liability for business debt and legal action taken against the business. (For corporations, personal liability protection also extends to other stakeholders in the business, such as members of the board of directors and officers.) This offers protection for the business owners’ personal assets, such as their home, bank accounts, cars, and retirement savings. However, a court might hold LLC members or a corporation’s shareholders responsible for the company’s debts and legal issues if they:
- Personally guaranteed or cosigned business loans
- Commingled business and personal funds
- Acted fraudulently
- Acted recklessly, causing harm to someone
- Failed to fulfill business compliance responsibilities to keep the entity in good standing with the state
Owners’ Pay
Owners of a “disregarded entity” LLC (one that has not elected S Corp tax treatment) typically cannot be made employees of their company. Therefore, they do not get paid through company wages or salaries. Instead, LLC members take money out of their share of the company’s profits. In a single-member LLC, the owner withdraws money by taking an “owner’s draw.” In a multi-member LLC, when any of the members needs money, the individual takes a draw from the LLC, which is recorded in that person’s capital account (a log of the member’s ownership shares and financial activities in the business).
There may be alternate ways of paying LLC members under certain circumstances. A tax advisor or accountant can help business owners explore their options.
In a corporation, shareholders who work in the company are put on the company payroll, and, like other employees, get paid wages and salaries. Shareholders may also receive money through profit distributions based on the stock they hold in the corporation.
Formation Requirements
Forming an LLC involves filing a form called “Articles of Organization” (sometimes called “Certificate of Organization) with the Secretary of State (or whatever a state’s comparable agency is called). Incorporating as a C Corporation involves filing “Articles of Incorporation” (or “Certificate of Incorporation”).
If an LLC or corporation wishes to be taxed as an S Corporation, it must file federal Form 2553 with the IRS. There might also be state paperwork to complete to be treated as an S Corporation for state income tax purposes. (Note that not all states will treat S Corporations differently than their underlying entity type!)
Other Possible LLC and Corporation Startup Requirements
- Select a board of directors (corporations).
- Designate a registered agent.
- Obtain any necessary business licenses and permits related to their location, industry, and professional activities.
- Have an LLC operating agreement or adopt corporate bylaws that document how the affairs of the business will be conducted. While companies do not have to submit these legal documents to the state, they must keep them in a safe place at their business so that they are available to all the business’s owners and other stakeholders.
- Obtain an Employer Identification Number (EIN), which is a federal tax ID number from the IRS.
- Open business bank accounts.
- Register for payroll taxes (if hiring employees).
- Submit an initial report.
- Issue stock certificates to shareholders (corporations).
Tax Treatment
By default, the IRS will consider an LLC to be a “disregarded entity.” That means it is the same tax-paying entity as its owners. Income taxes for disregarded entity LLCs are handled on a “pass-through” basis. The LLC itself does not file a business tax return or pay business income tax. Instead, the LLC members report the LLC’s profit and losses on their personal tax returns and pay tax according to their individual tax rates. LLC members, because Social Security, Medicare, and income taxes aren’t withheld from their paychecks (Remember, they aren’t on payroll!), must pay income tax and self-employment taxes on their company profits. They usually do so through quarterly filings with the IRS, state, and local tax agencies.
A C Corporation is its own tax-paying entity. Its profits are taxed at the corporate level (subject to the corporate tax rate) and then taxed at the shareholder level (at the applicable individual tax rates) when distributed as dividends. You’ve likely heard that turn of events called “double taxation.” That is because dividend payments are not tax-deductible to the business, thus creating a double tax event. Another important note about corporate taxation is that shareholders may not deduct the business’s losses on their individual tax returns.
LLC and C Corporation owners, if they meet the IRS’s eligibility criteria, may opt to be treated as an S Corporation. Like an LLC, an S Corporation is a pass-through entity. However, the tax methodology is a bit different. In an S Corporation, owners are on the company payroll and only pay Social Security and Medicare taxes (FICA) on their wages and salaries from the business. Income taken as distributions is subject to income tax but not FICA taxes. So, this may help some business owners lower their overall tax burden.
When a C Corporation opts for S Corporation treatment, the corporation files an informational return but does not pay income taxes at the corporate rate. Profits and losses flow through to shareholders’ individual tax returns. As I described above for LLCs that choose S Corporation election, owners who are on the payroll, only pay FICA taxes on their wages and salaries. Profit distributions are not subject to those taxes. The primary advantage of S Corporation status for C Corporations and their owners is that it eliminates double taxation.
Raising Capital
To raise funds for the business, an LLC can sell ownership interests in the company (as allowed by the provisions in its LLC operating agreement). A corporation may issue shares of stock to raise money. C Corporations can issue multiple classes of stock (for example, common and preferred), while S Corporations may issue only one class (common stock).
Business Compliance
As statutory entities, LLCs and corporations have ongoing filing and reporting requirements to remain in compliance with the state’s laws.
LLCs have fewer obligations than corporations. What must be done varies depending on the state.
Common LLC business compliance tasks:
- File an Annual Report
- Maintain a registered agent
- Renew business licenses and permits
- File tax returns and pay taxes on time
- Hold an annual member meeting and record minutes
Common corporation business compliance tasks:
- File an Annual Report
- Maintain a registered agent
- Renew business licenses and permits
- File tax returns and pay taxes on time
- Hold an annual shareholder meeting and record minutes
- Hold regular board of directors meetings and record minutes
Perpetual Existence
An LLC or corporation may live on in perpetuity unless its formation documents state otherwise or its owners file articles of dissolution (or the state administratively dissolves the entity for non-compliance). In other words, these business entities can survive even if the original owners leave the company or pass away. It’s important for an LLC’s operating agreement or a corporation’s bylaws to have a provision that lays out what happens to the business when members are no longer part of the company.
Why Start an LLC or Corporation?
Unlike sole proprietorships and general partnerships, operating a Limited Liability Company or corporation brings some notable perks within the realm of possibility.
- Peace of mind that personal assets aren’t at risk if the business runs into legal or financial problems
- Tax flexibility (and possibly more tax deduction opportunities than sole props and partnerships)
- Heightened credibility (“LLC” or “Inc.” after a business name may increase customer, employee, and investor confidence in the company.)
- More opportunities to raise capital to fund growth and expansion
- Perpetual existence, so the business can keep going even if something happens to its owners
With so much to consider when choosing a business structure, it’s critical to research the options and ask trusted legal, tax, and accounting professionals for expert guidance. After you’ve decided which entity type will be most advantageous in your situation, know that CorpNet is here to help with your important business filings, including state registration paperwork, state payroll tax registration, EIN application, and more.
Contact us to make the process seamless so that you can concentrate on starting your business on the path to success!
