LLC vs Corporation Pros and Cons

When examining the differences between an LLC and a corporation, it is essential that the two business structures be properly defined.

A limited liability company combines elements of a partnership or sole proprietorship and a corporation. It offers legal structures that are less restrictive, fewer maintenance needs, while still offering the benefits of limited liability and pass-through taxation.

Corporations are structured differently because there are multiple types available. An S-corporation is a pass-through entity, just like an LLC. Most comparisons are with a C-corporation, which doesn’t offer that structure because it is taxed separately. They pay taxes on the profits, then the owners must pay personal taxes on their compensation earned as well.

For the average small business owner, the benefits of an LLC far outweigh the disadvantages which come along, especially when compared to the structure of corporations in the United States. You are afforded more protections than a partnership, have minimal administrative responsibilities, and the costs aren’t going to break most budgets.

Here are the LLC vs corporation pros and cons to evaluate before you formalize the structure of your first (or next) business opportunity.

List of the Pros of an LLC vs. Corporations

1. The formation of an LLC is much simpler than that of a corporation.

Both LLCs and corporations create separation between the personal and business assets of the owner(s) involved. What makes the LLC an easier option is that it is a hybrid between the partnership structure and the corporation. You’ll be required to file your articles of organization after choosing an available business name in your state. Then an operating agreement is required to outline the rights and responsibility of each owner (member). Publish your intent to form if required, obtain your licenses and permits, and you’re ready to go.

To form a corporation, you must appoint an initial set of directors that will run the company. You’re required to create bylaws for the company, hold a meeting of the board, and issue stock certificates.

2. You have unique taxation options with an LLC.

You can choose as an LLC to be taxed using pass-through methods or to be taxed separately as a business. No matter what option you choose, you’re still providing a level of protection for your personal assets with the structure. If you’re operating a solo LLC, you can even choose to be taxed like a sole proprietor in some states. That means you have more flexibility in how income is reported.

With a corporation, you don’t have the pass-through option. Whether it is an S-corporation, a C-corporation, or a similar structure (like a B-corporation), you are taxed as a business only.

3. LLCs are permitted an unlimited number of owners.

If you decide to form an LLC, you and an unlimited number of friends, partners, or family members can sign on to the company. Although you’ll need to outline the roles and responsibilities of each member, there is no limit to the number of owners permitted in most states. Ownership isn’t restricted either, so individuals, other LLCs, corporations, and even foreign investors are permitted. Most states allow for a single owner also.

With an S-corporation, you’re limited to a total of 100 shareholders. A C-corporation is a publicly-traded company, so anyone with enough money and the representation to buy and sell can own stock, which represents a portion of equity.

4. You are permitted to contribute assets to an LLC.

Unless an LLC is electing to be taxed as a corporation with different classes of membership, the owners are permitted to contribute assets to the company in a nontaxable transfer if they are solely for stock. Contributions to an LLC taxed as a partnership are governed by the rules which oversee partnerships in the United States.

Owners are permitted to loan money to their LLC if the business requires it. Interest can be added to that amount, then repaid to the owner without those funds counting as income to the individual. Even though it isn’t technically a separate business entity, in some ways it still is. With a corporation, the rules become much more complicated.

5. LLCs offer management flexibility.

If you structure your business as a limited liability company, then you can choose to be the person in charge of all decisions. You can also choose to designate a manager to make those decisions for you. All members can have a say in the direction of the company, or the agreement declarations as part of the formation process may offer that responsibility to specific owners only. Like a sole proprietor or a partnership, the final decisions rest with you or the people you designate.

With a corporation, that is not the case. It is the board of directors, appointed initially during the incorporation phase of the business, which has the final say on matters. The Chief Executive Officer reports to the board. It is possible for a CEO to be the President of the board of directors to have greater control, but there is not the same automatic flexibility with this option as there is with an LLC.

6. The cost of starting an LLC is much lower than that of a corporation.

There are different filing fees, permit costs, and licensing charges in all 50 states when you want to create a business with either an LLC or corporate structure. In the U.S., the average cost to start an LLC is $127. The state filing fees for this business structure range from $50 up to $500. That does not include the cost of hiring a registered agent if you’re filing for an out-of-state business structure.

To start a corporation in the United States, the average filing cost is between $100 to $250 for the articles of incorporation, according to data published by Legal Zoom. Most states require you to pay a first-year franchise tax for the privilege of doing business in the state, which is between $800 to $1,000 per year. Then you have the various fees for the different filings that are required.

Even if you live in a pricey LLC state, you’ll still pay 50% less during the startup phase compared to the costs of beginning a corporation.

7. LLCs offer no restrictions concerning payment amounts.

When a business is structured as an LLC, then there is no requirement about how much (or how little) each owner is paid in the company. Under both taxation options, the members of an LLC can be paid at a different percentage than their equity. That makes it possible for each owner to receive the exact number of write-offs which are necessary to maximize their reimbursement package.

In a single-owner LLC, you would always receive all the profits.

When a business is a corporation, the salary is a little different. If you are a shareholder and an employee of this business, then the IRS is permitted to reclassify anything they deem to be “excessive” in the salary given as a dividend distribution. The excessive portion can no longer be deducted as a business expense for the company, but then the individual involved can pay the lower capital gains tax rate instead of their standard income tax bracket rate on the amount.

8. LLCs permit you to deduct health insurance premiums.

Under the structure of an LLC, you are permitted to deduct the premiums from your health insurance policies from your wages. The amount allowed by the IRS is based on the prorated net profits which are earned by the company. Every member who earns income through the LLC is able to take advantage of this benefit. All profits within the LLC get to be counted as earned income.

Corporations are a little different. Accident and health insurance premiums paid on behalf of a 2% S-corporation employee are deductible by the business and count as reportable wages on the W-2 form of the worker. That means the compensation offered for the health insurance is subjected to income tax withholding. Certain deductions that are similar to what LLC owners receive are possible if specific IRS rules for self-employment are otherwise met.

9. LLCs and corporations allow for foreign ownership.

In general terms, foreign ownership of a business formed in the United States is permitted. The procedure for foreign citizens to form companies in the U.S. is the same as they are for domestic citizens. It isn’t necessary to have a green card to be an owner with a corporation or a limited liability company either.

The difference between the two comes back to pass-through profit distributions. With a C-corporation, all profit distributions are subject to double taxation. Foreign citizens are not permitted to own any shares in an S-corporation. That’s why international investors typically use the LLC structure when they want to get involved in a business opportunity. It avoids the business tax/personal tax combination.

10. LLCs are much easier to dissolve when compared to corporations.

If you’re ready to call it quits on the business, then an LLC is much easier to dissolve than a corporation. The members must first vote to dissolve the company, which should follow the procedures outlined in your operating agreement. If that isn’t possible or available, then follow the local statues for dissolution. Then memorialize the vote in a resolution to keep with your records.

From there, you should notify your creditors of the decision, resolving any outstanding debts whenever possible. You have between 90 to 180 days (depending on your state) where claims must be accepted. You might be required to notify creditors before filing dissolution papers. Then notify the taxing and licensing authorities and you’re through.

To dissolve a corporation, you must follow these specific steps.

• A board meeting must be called, then a vote is taken and the minutes recorded to show that the dissolution was approved.
• Shareholders (if there are any) must approve the dissolution. Some states require a 67% majority for this approval.
• A certificate of dissolution must be filed with the governing authority, usually the Secretary of State.
• Then you contact the IRS, close your accounts, end your credit lines, and similar steps.

If each step for either the LLC or the corporation is not handled properly, then the company could be considered open for business, even if no one is working. That would create unique tax responsibilities which could involve personal responsibility.

11. Less formality is associated with an LLC compared to a corporation.

LLCs are not required to have a board of directors, specific meetings, keep minutes, or prove that a quorum was achieved to conduct transactions on a regular basis. Many of the formalities of the corporate world involve administrative duties, whereas the LLC has fewer paperwork requirements to follow throughout the year.

List of the Cons of an LLC vs. Corporations

1. An LLC receives fewer capital investment opportunities.

When comparing the two business structures from an investment standpoint, a corporation is more attractive than an LLC. With the limited liability company, the owners who are present at the formation are not permitted to buy, sell, or trade their share of the company for any reason. If an LLC owner must leave the company, the organization is forced to dissolve before it can reform. In some situations, that may even mean the assets must be liquidated first.

Corporations are permitted to buy, sell, or trade equity within the company. That allows the corporate structure to have more continuity compared to the LLC structure.

2. The IRS automatically taxes LLCs in a default way unless you state otherwise.

In the United States, the Internal Revenue Service (IRS) does not classify LLCs as an official business structure. Only sole proprietors, partnerships, S-corporations, and C-corporations are classified as businesses. That means a single-member LLC will be automatically taxed like a sole proprietor, while multiple-member LLCs are taxed like a partnership. If you want to save the 7.65% in self-employment tax required by the government for Social Security and Medicare, then the LLC must declare to the IRS that they wish to be taxed in a different manner.

3. The personal asset protections of an LLC may not apply.

To take advantage of the separation between personal and business assets, the owners of the LLC must keep their books separate from each other. If an owner mixes their personal assets with their business assets, then the courts may rule that creditors can pursue their home, vehicle, and other personal properties that are owned outside of the company. This issue typically applies to single-member LLCs who are used to operating as a sole proprietor, but the rules apply across the board.

With a corporation, asset protections are stronger, especially when operating under a C-corporation structure. There are some circumstances when they might not apply, however, such as when a personal guarantee is made on a debt, there is evidence of fraud, or personal funds have been used to pay company debts.

4. LLCs have no path forward when a member leaves for any reason.

When an LLC is formed, there are not options for continuity. The business is based on the equity each member brings to the original agreement. If an owner of the company leaves for any reason, including death, then most states require that the LLC dissolve. Then the remaining members can form a new LLC if they wish.

Corporations offer continuity. If one of the owners leaves or passes away, their equity in the company can be inherited, sold, or traded to someone else. The only stipulation is that an S-corporation cannot go over 100 members through the transaction. If you want to have something to leave your children one day, then a corporate structure, not an LLC, is going to be a better option.

5. There are no salary requirements with an LLC.

Most LLCs take advantage of the default taxation structure that permits pass-through compensation to each owner from net profits. That means the obligation to pay a salary disappears. Members are assigned a portion of the profits based on their initial agreement or the equity they hold in the company. If a payment is sent to an owner, even if it is intended as a paycheck, the action is counted as a draw for tax purposes. It won’t count against the income of the company, so your personal tax obligations are higher.

With a corporation, owners can earn a salary while they also earn dividends from the equity ownership. Although excessive salaries can cause problems with business taxation with C-corporations, S-corporations use a similar pass-through structure.

6. The annual renewal fees are the same, if not higher, for LLCs in most states.

Most states require corporations and LLCs to file an annual report making specific declarations. If these reports are not filed and the fee for them is not paid, then the company is no longer authorized to conduct business unless they follow the same process to organize during the initial formation process.

This report and fee combination is where the financial advantages typically end for an LLC vs corporations. Most states charge the same fees to renew. Washington State, for example, charges a $60 fee when filing an annual report online or $110 for an expedited paper report.

7. Corporations aren’t required to hold separate state licenses.

With an LLC, you may be asked to file for a separate business presence to conduct transactions in multiple states. For corporations, most states allow an organized company to register as a foreign corporation instead, operating under a certificate that is usually cheaper than what an LLC organization would be asked to pay. The certificate acts as a business registration for the company, allowing the corporation to operating in good standing, with legal existence, once received.

8. LLCs are not permitted to offer stock options or bonuses.

Corporations are allowed to offer more incentives to their employees, including people who are designated as shareholders and workers within the company. An LLC distributes income based on whatever methods they prefer, but there are no bonus options available. A corporation is permitted to offer workers access to stock options, to pay them stock bonuses, and offer other incentives because of the structure of shares. Both owners hold equity, but the corporation’s equity offers tradeable value, while the LLC equity does not.

9. An LLC is not permitted to hold an IPO.

An IPO stands for “initial public offering.” It refers to the first sale of stock issued by a company to the general public. Before the IPO, the organization is considered a private company with professional investors. When they “go public,” the stock allows everyone not involved in the private days of the company to purchase shares. Those shares hold an equity value in the company, allowing holders to own a small percentage while the organization raises funds from the sale.

An LLC cannot do this at all. It would be forced to restructure itself before wanting to raise capital in such a way. The only option available is a debt instrument, such as a bond, as no current state statute prohibits using that vehicle.

The pros and cons of an LLC vs. corporations depend upon how many owners are involved, the size of your company, and how you want your compensation to be taxed. You might pay higher taxes with an LLC in some ways because of self-employment requirements. Your company might pay higher taxes under certain corporate structures. If you’re unsure of how to proceed, then be sure to hire an attorney familiar with these organizations to ensure you form a business the correct way.