Deciding between an LLC and a Corporation

When starting a business, one of the most important decisions you’ll make is choosing the right legal structure. Limited Liability Companies (LLCs) and Corporations represent two of the most common options. Each has its own advantages and disadvantages, so it’s crucial to conduct diligent research, understand the differences, and consider your specific business needs before making a decision.

The following information can serve as a guide during the first stage of your research, but we strongly recommend that you consult with a business planning attorney to learn more specific details of these business structures – particularly as they pertain to your organization – before making a decision.

Limited Liability Company (LLC)

An LLC is a flexible and relatively simple business structure that combines elements of partnerships and corporations. Electing the LLC structure will confer the following benefits:

Limited Liability. One of the primary benefits of an LLC is that it provides limited liability protection to its owners (also known as members). This means that the personal assets of the members are protected from business debts and liabilities. In the event of a lawsuit or bankruptcy, creditors typically cannot go after the personal assets of the members.

Pass-Through Taxation. LLCs provide options with regard to taxation, allowing the business to choose how it is taxed. Many business owners prefer S elections, meaning that business profits and losses are passed through to the owners’ personal tax returns. This avoids double taxation, as the business itself does not pay taxes. Instead, members report their share of the profits or losses on their individual tax returns.

Flexibility. LLCs offer greater flexibility in terms of management structure and ownership. They can be managed by the members themselves (member-managed) or by appointed managers (manager-managed). Additionally, there are no restrictions on the number or type of members an LLC can have.

Less Formality. Compared to corporations, LLCs have fewer formal requirements and ongoing compliance obligations. There is no need for annual meetings, extensive record-keeping, or complex corporate formalities.

Note: An LLC is not an option for all businesses. For example, professional practices are prohibited from utilizing this structure.

On the other hand, an LLC is often the best solution for certain endeavors, such as real estate holdings.

Corporation

A corporation is a separate legal entity owned by shareholders. Business owners might choose to incorporate for many reasons, but the most common ones include:

Limited Liability. Like LLCs, corporations provide limited liability protection to their owners (shareholders). Shareholders are not personally liable for the debts and liabilities of the corporation.

Corporate Taxation. Unlike LLCs, corporations are subject to double taxation. This means that the corporation itself pays taxes on its profits, and then shareholders pay taxes on any dividends they receive. However, corporations can also choose to be taxed as S corporations, which allows them to pass through income to shareholders and avoid double taxation. It’s important to note that most CPAs prefer their clients use the formal S Corporation structure due to its unique tax benefits.

Formal Structure. Corporations have a more rigid structure and are subject to more formalities than LLCs. They must hold regular meetings of shareholders and directors, maintain detailed corporate records, and adhere to specific corporate governance requirements.

The increased structure of a Corporation (Officers, Directors, Shareholders, etc) can be beneficial for organizations with multiple layers of management or ownership. Many LLC owners attempt to build this into their Company later, but it is usually easier to use the Corporation’s structure from the very beginning.

Attractiveness to Investors. Corporations are often more attractive to investors, as they can issue stock and raise capital by selling shares. Additionally, corporations have a perpetual existence, meaning they can continue to operate even if ownership changes.

Note: In some cases, the Corporation structure is required – such as for professional practices.

Choosing Between an LLC and a Corporation

So, how do you know whether to choose an LLC or a Corporation for your business? Consider the following factors.

  • Both structures can protect your personal assets from business liabilities, but other factors will vary.
  • Consider how you want your business to be taxed. Both structures can allow pass-through taxation. However, if you plan to reinvest profits into the business or attract outside investors, a corporation may be the better choice.
  • If you value flexibility in management structure and ownership, an LLC may be more suitable.
  • If you plan to seek outside investment or go public in the future, a corporation may be more attractive to investors.
  • If you plan to hold physical assets, such as equipment, inventory, vehicles, or real estate, an LLC can be preferable as a holding company.

While both LLCs and corporations offer unique benefits and drawbacks, the decision process will depend on your specific business goals. Schedule a consultation with our business planning attorneys so that we can help you analyze your needs in more detail, and then together we will determine the best option for your particular situation. By carefully considering all relevant factors, you can make an informed decision that sets up your business for success.

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This article is for informational purposes only and does not constitute legal advice. For personalized advice, please contact California Business Formations.

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