BUSINESS LAW & PLANNING STRATEGIES
LIMITED LIABILITY COMPANIES

An LLC, or Limited Liability Company is a legal entity created under California law. An LLC comes into existence upon the filing of what are called Articles of Organization with the California Secretary of State.

LLC stands for “limited liability company.” An LLC is one type of legal entity that can be formed to own and operate a business. LLCs are very popular because they provide the same limited liability as a corporation.

The LLC form of doing business combines the best parts of corporations, sole proprietorships, and partnerships into one business entity offering owners liability protection, flexible management structure, and certain tax advantages.

A limited liability company is a business entity that is separate from its owners, like a corporation.

For income tax purposes, an LLC can elect to be taxed as a C Corporation, an S Corporation, a Sole Proprietorship or a Partnership by filing certain forms with the IRS and the California Franchise Tax Board. Thus an LLC can be an LLC under non tax law with all of the state laws that apply to LLCs, but treated as a different type of entity for income tax purposes. There is no such thing as being taxed as an LLC for income tax purposes.

LLC vs. Partnership

Organizing your small business as a limited liability company or as a partnership affects three key areas:

  • taxation,
  • operation, and
  • owner liability.

If your business has two or more owners, assuming you do not want to form a corporation instead, you can structure it as a limited liability company (LLC) or a partnership. The two options have similarities but also a number of differences in the way they’re run, the way they’re taxed, and the type of liability protection that owners receive.

Below are LLC and partnership features, advantages, and disadvantages.

LLC vs. Partnership: Liability for Business Debts

Persons who start a business together are deemed automatically have a general partnership unless other steps are taken.

A general partnership is relatively simple to set up and maintain. However be warned, the partners are each fully liable if a creditor obtains a judgment or owes other debts. For this reason alone, except in unique circumstances, I generally do not advise the use of general partnerships.

As an alternative, the parties can set up a formal business entity such as an LLC, limited partnership, or limited liability partnership (for certain California professionals in qualifying professions).

In each of these business types, generally the owners have limited personal liability. Business creditors can go after company assets, but the owners’ personal homes, bank accounts, investment properties and other assets are safe.

LLC

An LLC is not a partnership for California non tax law purposes, though many LLC owners casually refer to their co-owners as “business partners.”

All LLC owners—known formally as “members”—are protected from personal liability for business debts of the LLC unless they personally guaranty the debt or they are the or a cause of injury to someone.For example, while driving the company vehicle one of the members injures a third party. The member will have personal liability for causing that injury, and the LLC for whom the member was driving on company business or in a car owned by the LLC, will also be liable. Make certain the LLC carries a lot of insurance, and names the owners as additional insureds.

Limited liability partnership.

California allows limited liability partnerships. Different states have different rules for such partnerships. Most allow limited liability for some or all of the partners, but some states hold partners liable for business debts or require at least one partner to be fully liable. And some states limit LLPs to certain professions.

Limited partnership

A limited partnership has at least one general partner and at least one limited partner. The general partners run the company and remain fully liable for business debts. The limited partners are passive investors who cannot be involved in decision-making and aren’t liable for company debts. Limited partnerships are mainly used in commercial real estate and other industries that need to raise money from a group of passive investors. Limited partnerships are also used in California instead of LLCs where the owners expect to have large gross receipts for the business each year and wish to avoid the California LLC gross receipts tax.

The Tax Differences Between an LLC and a Partnership

Interestingly, a multi member LLC is taxed as a partnership for income tax purposes, as a default, because the the tax code automatically classifies both LLCs and partnerships as pass through entities. This means that owners report their share of company profits and losses on their personal tax returns.

However, an LLC does have advantages over a partnership in that an LLC can also elect to be taxed as a corporation. Some LLC owners find that they can save money on taxes and boost their retirement savings by electing S corporation status. However, not all LLCs qualify to be taxed as S corporations.

Taxation is a complex and ever-changing topic. Consult us to see whether you could see a tax benefit by organizing your business as an LLC as opposed to a partnership.

Organizing and Running LLCs vs. Partnerships

Both LLCs and limited partnerships are created by filing forms with the state of California. General Partnerships do not have any required California state filings.

There are some differences in the way the two types of businesses are conducted.

An LLC doesn’t require a general partner. Instead, it can be managed by its members or by a group of managers, with the other members acting as passive investors. The LLC operates according to its operating agreement, a document that includes such things as how profits and losses are distributed, capital contributions of each member, how decisions are made, and the procedure for adding new members or dealing with departing ones.

An LP operates similarly to an LLC, except that the governing document is a partnership agreement rather than an operating agreement. All general partners can participate in running the company. Generally, limited partners cannot. However, a limited partner who is also officer of a corporate general partner can participate in managing the LP business without losing his status as a limited partner.

In general, an LLC offers better liability protection because it does not require a general partner with exposure to unlimited liability. An LLC that makes an S Corporation election for tax purposes can avoid or minimize payroll taxes on the owners’ income. Other than that, the income tax aspects of the two are equivalent.

LLC or LP: What’s Best for Your Business?

Understanding the relative benefits and limitations of an LLC and an LP is important when determining which type of entity would be best suited for your company.

Introduction

Limited liability companies (LLCs) and limited partnerships (LPs) are two of the most popular business entities. If there are two or more owners and the parties have decided they do not want to use a Corporation, then they can choose between these two business formation options.

Factors in making a choice

Following are some of the factors you need to evaluate when deciding whether an LLC or an LP would work best for your business.

When an LLC is the better choice

In general, an LLC might be better if one or more of the following apply:

You want all owners to have limitation of liability for company debts
All owners will participate in managing the company
You want the option of electing to be taxed as a corporation such as a S Corporation

When an LP is the better choice

An LP might be better if any of the following apply:

You want passive investors who you do not want to participate in management decisions
You already have an LLC that will serve as the general partner
You are not particularly concerned about the personal liability of the general partner
You want to avoid the California LLC gross receipts tax

Taxation Differences

The Internal Revenue Service (IRS) treats both LLCs and LPs the same for tax purposes upon formation. that is, formation is generally tax free, with some exceptions.

However, operationally, an LLC has the option of electing to be taxed as if it were a corporation. Limited partnership tax treatment doesn’t allow for such an election.

If partnership taxation is desired, there is no tax advantage to either type of entity. But if you want your company taxed as a corporation, you will need to organize the company as an LLC and then file the necessary IRS forms to elect corporate taxation treatment.

Dont’ forget state taxes. California imposes a LLC gross receipts tax unless the LLC elects to be taxed as an Corporation. California also imposes a state 1.5% income tax on S Corporation net income.

Organizational Differences

There are differences in how LLCs and LPs are structured and created.

Note: a member of an LLC, as well as a partner in an LP, may be an individual person, a corporation, another LLC, or another partnership.

LLC structure.

A person who has an ownership interest in an LLC is called a member. An LLC with two or more members is called a multiple-member LLC. Forming an LLC requires filing Articles of Organization, with the California secretary of state.

Many LLCs also have an Operating Agreement, which set forth the members’ ownership interests, rights, and responsibilities.

LP structure.

A person with an ownership interest in an LP is called a partner. In an LP, there are two types of partners: general partners and limited partners. There can be one or more general partners and one or more limited partners. Both own a certain percentage of the company, but only general partners can engage in operating the business. Limited partners are passive investors who share in profits and losses but have no say in how the business is run. Having passive investors is the main advantage of a limited partnership. Forming an LP is typically done by creating a Partnership Agreement, which spells out the ownership interests, rights, and responsibilities of the general and limited partners. As with an LLC, the LP must file a form with the California Secretary of State. That form is called a LP-1.

California prohibits certain types of businesses from organizing as an LLC. This commonly relates to certain professionals, such as accountants, architects, physicians, attorneys, dentists and certain types of businesses, such as banks and insurance companies.

Limitation of Liability

If a business is organized as a general partnership, all of the partners can be held personally liable for the business’s debts. This means that a partner is risking more than what they contribute to the business.

If the company’s debts are greater than the value of the company’s assets, a creditor can go after the partner’s personal property, such as their personal bank accounts, other investments, cars, and real estate. In fact, a creditor does not have to go after the Partnership’s assets first but can go after the general partners first or at the same time.

A central purpose of both an LLC and an LP is to limit the owners’ personal liability, but they do not provide the same degree of protection.

With an LLC, all of the members obtain limited personal liability. The members may also participate in the management of the business and keep their limitation of liability.

In an LP, only limited partners enjoy limited personal liability. However, this only applies if the limited partner takes no active role in managing the company. A general partner remains personally liable for partnership debts.

Some LPs resolve this problem by forming a separate LLC or a Corporation to be the general partner. But this requires setting up two entities, the LLC and the LP (or Corporation), and incurring the expense of forming and operating each.

LLC vs. Corporation

Millions of business owners form a corporation or an LLC to shield themselves from liability arising from business operations.

The questions is: which one to choose through which to conduct your business?

Once you understand your options and their attributes, you can make an informed decision.

Differences Between LLC and Corporation

“LLC” is an acronym for “limited liability company.” It is similar to a corporation, but offers somewhat more flexibility in management and taxation. In california, Corporations must have annual written minutes if the shareholders want protection from personality liability. By contrast, LLCs are not required to have annual written minutes.

Corporations have been used for many years and offer the following attributes:

  • well known structure,
  • perpetual life and
  • relative ease of share transferThese are all important features if you plan to seek outside investors. Corporations also have a definite going public, and merger and acquisition process compared to LLCs.

LLCs and corporations are both business entities  created by filing formation documents with the state.

Both provide their owners with the same type of liability protection: owners are generally not personally responsible for business obligations of either LLCs or corporations.

Corporation vs. LLC Ownership

The owners of a corporation are called shareholders. The corporation issues shares and each shareholder owns the number of shares that corresponds to his or her percentage of ownership. So if the corporation issues 10,000 shares and you own half the company, you’ll have 5,000 shares.

Unless the shareholders and corporation have entered into a Stock Transfer Restriction and Buy Sell Agreement, Corporate shares are relatively easy to transfer from one person to another, and corporations have a perpetual life—meaning a shareholder can leave, die or sell shares without threatening the corporation’s existence.

LLC owners are called members, and each member owns a percentage of the business, which is sometimes called a “membership interest.” There are almost always restrictions on transferring LLC membership interests either by statute or the LLC Operating Agreement. You may be required to get the other members’ approval, and an LLC must be dissolved if a member leaves, dies, or files bankruptcy.

If your business is small and you want to be able to choose your business partners, you may appreciate these LLC restrictions. If, however, you plan to seek outside investors or provide company shares to employees, then you’ll need a corporation’s easy share transferability and eternal life. In fact, venture capitalists and other professional investors will typically only invest in a corporation, because of the protections corporate law gives to shareholders and the statutory standards that corporate officers and directors are held to.

LLC vs. Inc. Management and Recordkeeping

Corporations have a fairly structured and historically tested management structure.

They must have a board of directors that oversees the company  and officers who run the company’s day-to-day affairs. They are required to hold annual shareholder meetings, must make annual reports, and generally have more demanding recordkeeping requirements than LLCs.

Most LLCs are managed by their members. These LLCs function much more like a traditional business partnership, and the members may not even have formal business titles, although some LLC operating agreements contain provisions for Company officers as well as managers. An LLC can also be managed by a group of managers. An LLC might choose to be manager-managed if it has members who own part of the business but aren’t involved in running it. LLCs have more minimal recordkeeping rules.

If your business only has one or a few owners and you are all active participants in the business, you may prefer to avoid the formality of a corporation and form an LLC. If, however, you expect to have many owners who are simply financial investors, the predictable structure of a corporation may be better for you.

S Corp. vs. LLC: Taxes for LLCs and Corporations

Corporations are taxed as either what are called C corporations or S corporations.

LLCs do not have a separate tax classification. However, they do have the ability to elect how they will be taxed.  As a result, LLC’s can be taxed as a sole proprietorship, partnership, S corporation, or C corporation.

Following is an overview  of how each of the structures listed above is taxed.

  • C corporations pay corporate income tax on profits. Their shareholders pay personal income taxes on the profits that are paid to them as dividends. This is characterized as “double taxation.”
  • S corporations avoid double taxation. S corporation profits pass through to shareholders’ personal tax returns, and shareholders are taxed on those profits.However, California does impose a 1.5% income tax on S Corporation net income.
  • Not all corporations and LLCs can be taxed as S corporations. There must be 100 or fewer shareholders; the shareholders can’t be corporations, partnerships, or nonresident aliens; and there can only be one class of stock. A corporation that is ineligible for S corporation taxation must be taxed as a C corporation, while an LLC can also choose to be taxed as a sole proprietorship or partnership.
  • Sole proprietorships and partnerships report business income on their owners’ personal tax returns. This structure works well for a small business that doesn’t have large profits. However, it can be expensive for a business that makes a lot of money: unlike corporate shareholders, sole proprietors, LLC members of a LLC taxed as a partnership and partners are considered self-employed and will be expected to pay Social Security taxes up to the maximum and Medicare taxes on all their profits.

S Corp vs. LLC

LLCs and S corporations are different types of formats of business operations. However, pursuant to tax law, they are not mutually exclusive.

Limited liability companies (LLCs) and S (Subchapter) corporations are often discussed together, but this is a mischaracterization.

What’s different about an LLC vs. an S corp. is that an LLC is a business entity while an S corp. is a tax classification.

The difference between an LLC and S corporation

What Is an LLC?

A limited liability company is a legal designation that can protect small-business owners from personal liability in business obligations. Owners of LLCs are known as members. LLCs can have one owner (single member LLC) or more than one owner (multi-member LLC). Owner-employees of LLCs are self-employed for self employment tax purposes.

LLCs offer a formal business structure, while they can also be taxed similarly to sole proprietorships, corporations or partnerships. An LLC is more flexible than a corporation in organization and profit distribution. An LLC can also choose taxation as a corporation, and owners can save money by electing S corp. tax status. An LLC taxed as a partnership can specially allocated net income among the members in a different ratio than capital ownership.

What Is an S Corp.?

An S corporation is a tax classification is generally designed to protect small-business owners’ assets from double taxation.

An S Corporation may or may not also be a corporation under state law. That’s because a company formed as an LLC under California can elect to be taxed as an S Corporation or a C Corporation.

An S corp. utilizes pass-through taxation, meaning an owner claims a share of company profits on their individual tax return. This ensures profits aren’t double-taxed (once under the corporation and again under the owner).

The “S” in S corp. stands for “subchapter,” because an S corp. is a subchapter corporation in that the provisions for the taxation of S Corporations are found in Subchapter S of the Internal Revenue Code.

When incorporating a business, you’ll first form a C corp. that must meet S corp. requirements to be so classified. The requirements include electing S corp. status two months and fifteen days after officially organizing your business (for the status to affect the current tax year), capping ownership at 100 individuals (not entities or partnerships), and limiting those owner shares to U.S. citizens only. If you form an LLC, you’ll also need to file IRS Form 2553 to elect a tax classification.

S corp. owners can be company employees. Owner-employees must pay themselves a reasonable salary for their work. They’ll pay federal and state income tax, Medicare tax, and Social Security tax on that salary. Owners receive additional profits as distributions, which aren’t subject to Medicare and Social Security taxes.

What’s the Difference Between an S Corp. and an LLC?

As explained above, an S corp. is a tax classification, while an LLC is a business entity. This means that an LLC can attain S corp. status if it meets certain criteria. However, LLCs and S corporations require different management and shareholder structures and have unique reporting requirements.

Owner Employment

LLC owners of an LLC taxed as a partnership or sole proprietorship are not characterized as employees.

S corporations can employ their owners and pay them a salary. An LLC that is treated as a corporation can also pay owners a salary. If your LLC makes a profit after paying owners a reasonable salary, you might save money on taxes by electing S corporation taxation.

Ownership Structure

By default, an LLC operates the same way as a sole proprietorship or partnership. However, an LLC can have unlimited owners (members) from all over the world; these owners can also be another corporate entity.

An S corp. and an LLC that elects to be taxed as an S Corporation must be a U.S. business owned by U.S. citizens and cannot have more than 100 owners. Beyond individuals, S corporations limit ownership to trusts and estates.

Management Structure

A corporation has a board of directors who make high-level, not day to day, decisions about running the business. Shareholders are responsible for electing directors to the board. Officer roles like president, vice president, and treasurer also exist to manage daily business operations outside the responsibilities of the board of directors.

Managers run LLCs rather than directors. Owners can participate in management (a member-managed LLC), or elect to hire managers to take on the responsibility (a manager-managed LLC). An LLC can also choose to appoint officer roles if that structure makes sense within the business plan.

Stock and Shareholders

An S corp. can only issue common stock, which gives voting rights to shareholders. An LLC does not issue stock and does not have shareholders, but rather must pay members according to the LLC’s articles of organization. If you decide to incorporate your LLC with S corp. classification, issue units or percentages, not stock.

Tax Liability and Reporting Requirements

Standard taxation for LLCs mirrors sole proprietorships (for single-member LLCs) and partnerships (for multi-member LLCs). Single- and multi-member LLCs can also elect to be taxed as C corporations or S corporations if they meet eligibility requirements. Non-S corp. LLC owners must pay a 15.3% self-employment tax on all net profits*.

S corporations have looser tax and filing requirements than C corporations. An S corp. is not subject to corporate income tax and all profits pass through the company. A C corp. must pay taxes quarterly in addition to owners paying annual income tax on their share of the profits.

Key Takeaways:

S Corp.: Owner can take a salary and avoid self-employment taxes on the rest of profits
LLC: Owner must pay self-employment tax on all net profits if taxed as a sole proprietorship or partnership

Cost To Establish

The cost of establishing an LLC and electing S corp. Status can vary depending on factors like which state you live in and whether you conduct business across state lines. Legal help will cost extra, but will likely save you money and time while helping you avoid common mistakes.

The average cost of filing articles of incorporation, not including lawyer fees, ranges from $100 to $250* depending on the particular state you file in. Forming an LLC costs between $50 and $500, depending on the state. If you do business in other states as an LLC, you’ll need to register to conduct business in each of those states, which will cost an additional foreign business registration fee.

Key Takeaways:

S Corp.: incorporation fees range from $100 to $250
LLC: formation fees vary from state to state, ranging from $50 to $500

LLC vs. S Corp.: Which Option Is Best For You?

LLCs and S corporations are different aspects of business structure. Choosing to pursue one, both, or neither classification could benefit your business in different ways. Take into consideration your needs when running a business, and ask yourself the following questions to get a better idea of which designation is right for you.

How many owners have a stake in your business?
Are all of your business partners U.S. citizens?
Does a partnership or corporation have a stake in your business?
How would a self-employment tax affect your net profit?

The answers to these questions can help you determine the fit of an LLC designation or S corp—classification for your business. Below, we’ll explore how the potential answers could affect you and your profits.
An S Corp. May Be Best For You If:

S corp. tax classification might be best for your business if you have plans to scale. S corporations require additional tax forms and payroll systems, which might not be worth the hassle if your business breaks even or makes a small profit. With an S corporation, you can also contribute more money to retirement plans and position your business for growth.

Separately, an S corporation might be right for you if your company reaches a consistent level of growth. A 15.3% self employment tax levied on an LLC’s profits is a steep tax liability to pay when revenues begin to tick upward.
An LLC May Be Best For You If:

You may want to establish an LLC if you’re concerned about personal liability but want minimal business upkeep. Legal requirements dictating the structure of an LLC are more lax than upkeep requirements for corporations.

Reporting requirements are generally simpler for an LLC than for a corporation. An LLC can have an unlimited number of owners. Partnerships, corporations, or noncitizens can own or partially own LLCs. The LLC should file an annual or biennial report that gives updates on current members, business locations, and other changes.

Which Is Better for Taxes: an LLC or an S Corp.?

Taxes on S corporations are lower than on non-S corp. LLCs. As an LLC owner, you’ll incur steep self employment taxes on all net earnings from your business, whereas an S corporation classification would allow you to only pay those taxes on the salary you take from your company.

However, itemized deductions could make an LLC a more lucrative choice for tax purposes. LLC owners can receive tax breaks for hiring a spouse or minor dependent and can transfer ownership of company property without incurring additional taxes.

Why Would I Choose an S Corp.?

You might choose an S corp. Classification if your company’s structure enlists many people with the task of running the company. A board of directors provides mandatory oversight for business decisions and can reign in rogue actors or veto decisions that might harm the company.
Should My LLC Be an S Corp.?

If your LLC is growing in profitability or you expect it to soon, you should consider S corp. classification. This allows profits to pass through the corporation into your wallet without incurring a hefty self-employment tax on all net earnings.

Both LLCs and S corporations offer personal liability protection that shields your personal assets. When starting a business, it’s important to think ahead and envision what kind of growth you want to achieve. Your goals and aspirations could determine which business entity and tax classifications are right for you.

What Is a Corporation?

A corporation, also known as a c-corporation, is a type of business structure that exists as a separate entity from its owners, who are called shareholders. The corporation pays its own taxes, can own property or enter a contract as an entity separate from its owners, and is responsible for debts or wrongdoing. Shareholders become owners by acquiring shares of stock in the corporation. They play a very limited role in managing the corporation, and they pay taxes only on the profit distributions they receive from the corporation.
What Is an LLC?

A business structured as an LLC is owned by one or more individuals or groups, known as members. LLCs are not separate from their members in the same way that shareholders are separate from the corporation. The LLC itself doesn’t pay taxes. Members pay taxes on the LLC’s profits on their personal income taxes, a process known as pass-through taxation. LLC members can run the company, although some LLCs choose different management structures.
What Is an S-Corporation?

Another type of corporation, an s-corporation, combines some elements of c-corporations and LLCs. Like c-corporations, an s-corporation is a separate legal entity, and shareholders have limited liability for the business’s debts and other obligations. But shareholders in an s-corporation are responsible for paying taxes on the business’s income in much the same way as members of an LLC.

How Ownership Works in a Corporation and an LLC

The rules for ownership, management, and other operations are spelled out for corporations in a set of bylaws. LLCs use an operating agreement to define responsibilities and rules of operation.

In a corporation, the number of shares of stock determines the percentage of the company a shareholder owns. Let’s say a corporation issues 100 shares of stock and sells each share for $10. A shareholder who invested $250 would own 25 shares of stock or 25 percent of the company. If the corporation distributed annual profits to shareholders, this shareholder would receive 25 percent of the distribution.

LLCs don’t issue stock. The operating agreement details the percentage of ownership and the share of profits (or losses) to which each member is entitled. A member’s share of profits is usually based upon the percentage of ownership, but an LLC can divide up profits in a different way, provided it follows the IRS “Special Allocations” rules.
Ownership Is Unrestricted for Corporations But Not LLCs

Shareholders of c-corporations are free to buy, sell, or transfer their shares to anyone on the open market.

LLC members can invest in the company or sell their investment only according to the rules established in the operating agreement (or the rules set by state law when no operating agreement exists). An LLC’s operating agreement might require members to sell their share back to the other members, or it might give the other members approval rights over any sale or buyer. A few states require LLCs to be dissolved and re-formed when a member leaves.
S-Corporations Restrict Certain Types of Ownership

While c-corporations can issue all their stock to a few individuals or thousands, to individuals or other businesses anywhere in the world, s-corporations can’t have more than 100 shareholders, and their shareholders must be U.S. citizens. Ownership in s-corporations is also limited to individuals, and other business entities such as corporations, LLCs or partnerships can’t own stock in the company.
How Corporations and LLCs Are Managed

In general, corporations must follow detailed state laws concerning management practices. LLCs are subject to fewer government rules about how they are managed.
How Corporations Are Managed

Corporations are required to have a board of directors and officers, such as a president and chief financial officer. The bylaws describe the rights and responsibilities of these executives, and most states require corporations to file their bylaws with the state.

Members of the board of directors are responsible for appointing the officers of the company and for overseeing and evaluating the direction of the business. A board of directors might get very involved if, for example, a corporation’s profits fall or the business records a loss. But it usually won’t participate in decisions like hiring, salaries, choosing vendors, and so on. Those day-to-day decisions are the responsibility of the officers of the company.

Shareholders might be asked to vote on decisions such as appointing new board members, but they typically don’t get involved in the day-to-day management of the company unless they are also officers.

Corporations are required by law to hold annual shareholder meetings and to keep minutes of those meetings. They also must issue annual reports.
How LLCs Are Managed

The equivalent of corporate bylaws for an LLC is called an operating agreement. But unlike corporations, most LLCs are not required to file an operating agreement, although a few states do require LLCs to create one.

LLCs have a lot of flexibility in deciding how the company will be managed. In most states, they need not have a board of directors, company officers, annual meetings, or annual reports. An LLC might be managed by all, or just some of its members; and some LLCs hire an outside manager with no ownership in the company to manage it.

Though only a few states require LLCs to issue annual reports, most require other annual filings in order for the company to retain its LLC status.
How Corporations and LLCs Pay Taxes

The corporation, not the shareholders, pays taxes on the profits the business earns. But shareholders are required to pay taxes on any dividends that are paid to them. Many view this tax rule, known as double taxation, as a disadvantage of the corporate structure. Corporations are also allowed many tax deductions for business expenses that can offset the tax bill.

S-corporations, on the other hand, don’t pay corporate taxes. Profits earned by the business are passed through to the shareholders (as is done with an LLC).

In an LLC, all the business’s profits (and its losses) are also passed through to the members. Single-member LLCs are taxed as sole proprietors; they report and pay taxes on business profits on their personal income tax returns.

LLCs with more than one member can elect to pay taxes as a partnership or a corporation. When taxed as a partnership, LLC members pay taxes on the company’s profits on their personal income tax return, based on their share of ownership.

When an LLC elects to be treated as a corporation for tax purposes, the LLC pays corporate taxes, and members pay taxes on any distributed profits. Members are not required to pay taxes on earnings that are retained, so profits that are re-invested into the company are not taxed.
How LLCs and Corporations Are Formed

LLCs and corporations are both formed by filing a document with the responsible state agency, usually the Secretary of State. Corporations file articles of incorporation and LLCs form articles of organization. (The documents might be called by different names in some states.)

The documents typically cover basic information about the business, such as the name and location of the company, the address of members (in the case of an LLC) or directors and officers (in the case of a corporation), the type of business, and its purpose. Corporations also need to provide the number of shares of stock they intend to issue.

Filing fees for corporations vary by state and sometimes by the number of shares the corporation issues. A business in Arizona might pay as little as $60 to file articles of incorporation, while Texas charges $300.

Fees for filing articles of organization for an LLC typically range from $50 to $100, depending on the state.

Corporations and LLCs are also subject to other annual fees, such as annual report filing fees, franchise fees, and business license fees.
Choosing Between a Corporate and an LLC Structure

Corporations and LLCs each offer the advantage of limiting the owners’ personal liability. The entity that’s right for you will depend on your needs. Here are some factors to consider:

LLCs have fewer formalities and offer more flexibility. In general, LLCs don’t require you to hold meetings or issue annual reports. And they offer a lot of flexibility in managing the company, whereas corporations are required by law to have a specific management structure, hold meetings, and observe other formalities.

Tax compliance is usually simpler under an LLC. LLCs don’t pay taxes unless the members elect to be taxed as corporations. Most members pay taxes on the business profits on their personal income tax filing. Corporations are subject to double taxation because the corporation is taxed on earnings, and shareholders pay taxes on the profit distributions they receive.

It’s easier to attract investors as a corporation. Investors prefer corporations because they can buy into the business or sell their stock on the open market, without restrictions. Buying into or selling ownership in an LLC usually requires the approval of the other members, and other requirements might apply. S-corporations also have ownership requirements that make them less advantageous for investors.

Corporations have more options for providing employee benefits. Corporations can offer benefit plans like stock options that most LLCs can’t. Tax deductions for many benefit plan expenses are also available to corporations, whereas LLCs can usually deduct only a portion of the expense of any benefits they offer.