It can be difficult to decide between an LLC vs. a corporation when you’re first incorporating. There are some important differences to consider. Which type of entity you choose will impact your yearly fees, whether you have to hold annual meetings, and how you go about limiting buying and selling of ownership interests.
Difference Between LLC and Corporation: Structure
Like a Corporation, an LLC offers limited liability to its owners. Unlike a corporation the Delaware LLC members have protection from creditors of the business, and also from future personal creditors of other members to keep those hostile creditors from taking over and liquidation the business. Unlike a corporation, Delaware LLCs are “creatures of contract”; they are constructed however you want, depending on how the LLC Agreement is written.
An LLC has an operating agreement that functions like a prenuptial agreement with other members to help resolve disputes before membership disagreements arise. In a corporation, there is no “built-in mechanism” or agreement between shareholders to resolve disputes.
Difference Between LLC and Corporation: Flexibility
The maximum contractual flexibility afforded by the Delaware LLC is not available to corporations. Corporations have strict rules and formalities that must be followed, like “dance steps”, that make them administratively burdensome to operate. The Delaware LLC is the preferred form of business for its flexibility, predictability and protection.
The Delaware LLC is recommended and should be selected if you are in doubt of what type of entity to form. You can always convert to a corporation later, if needed. LLCs also have the tax flexibility of a corporation, if elected, as well as the preferred method of partnership/sole-proprietorship election not available to corporations. Therefore, unless investors are requiring the corporation and its strict formalities and strict fiduciary duties, the LLC should be selected. The LLC is also the most popular entity filed in the US and selected more than any other business entity.
Difference Between LLC and Corporation: Taxes
By default, an LLC has a federal tax status of a partnership for a multi-member LLC or the tax status of a sole proprietorship for a single member LLC. These are “pass-through” entities for tax purposes. All of the profits and losses pass-through the business to its members (owners) or sole member. These owners then pay taxes on the profits, or deduct the losses, on their individual 1040 personal income tax returns. Therefore, the business entity does not pay taxes directly. Instead a multi-member LLC only files an informational partnership tax return referred to as an IRS Form 1065. Then its members receive a K-1 for their share of the profits or loses. By agreement, this amount can be distributed disproportionate to ownership percentage.