The Difference Between LLCs and Corporations — Which Is Best for You?

Man pointing to words Pros and Cons

If you are starting a new business, purchasing a business, or planning to grow your existing business, one of your most important decisions is determining what legal structure your business should have. The choice you make can potentially affect all of your operations and will determine what legal requirements the business will need to satisfy.

Determining Business Structure in North Carolina

The decision on the structure of your business should be made near the beginning of the planning process. North Carolina requires most businesses other than those operated as sole proprietorships to register as a specific business type with the North Carolina Secretary of State. The choice of business type will also affect how you file federal and state tax returns for yourself and for the business.

An important step in the decision-making process is consulting with a knowledgeable business formation attorney who can help you assess all the ramifications of your choice of legal entity. In eastern North Carolina and throughout the Outer Banks, our business and corporate attorneys at The Twiford Law Firm have the experience to provide you with comprehensive guidance throughout the complex processes involved in business planning, formation and management.

The two most popular business types are LLCs and corporations. Having a basic understanding of the differences between an LLC and a corporation will provide groundwork for you to talk with one of our attorneys about the type of legal entity that will be best for your business.

What Is an LLC?

LLC stands for “Limited Liability Company.”An LLC is not a type of corporation. It is a legal structure that provides the limited liability benefits of a corporation but is treated differently than a corporation for taxation and operational purposes. The owners of an LLC are referred to as “members.”

An LLC is a “pass through” entity, which means that profits and losses are passed through to members and reported on their personal tax returns. The tax treatment is similar to that of a partnership or sole proprietorship.

What Is a Corporation?

A corporation is a separate legal entity from its owners, who are referred to as the “stockholders” or “shareholders.” The owners of a corporation are protected from personal liability on corporate debts. A corporation is taxed as an entity separate from the owners. As such, unlike LLCs, corporations are not “pass through” entities.

Corporations file special corporate tax form. They are taxed on profits and earning at corporate rates, which are usually higher than individual tax rates. A corporation generally retains some profits and earnings as part of operating capital.

Many corporations distribute part of their profits can be to shareholders as dividends. When a stockholder receives a corporate dividend, the dividend is taxed as part of the stockholder’s personal income. Because the corporation also paid taxes on the distributed profits before they became dividends, those profits are essentially taxed twice. That is the reason that corporations are sometimes described as business entities that have “double taxation” of profits.

Taxation Is Not the Only Difference Between LLCs and Corporations

There are important differences between LLCs and corporations in a number of areas beyond taxation, including:

Profit Reinvestment

A corporation offers more flexibility in terms of reinvesting profits in the business than does a pass-through entity such as an LLC. Since shareholders of a corporation are only taxed on dividends they receive, the corporation can allocate a portion of profits to capital and leave those profits in the business without subjecting the shareholders to tax liability on those profits. In contrast, if the members of an LLC leave profits in the business to use as capital, the members are still responsible for paying individual taxes on those profits.

Transfer, Succession and Continuity

Whether a corporation is public or private, the company’s shares of stock are easily transferable. An owner who wishes to withdraw from ownership simply transfers the stock to another person. In an LLC, when a member wishes to withdraw, the member’s ownership rights are not transferrable. In some cases, an LLC will automatically dissolve if a member withdraws.

Raising Capital

A corporation can issue additional shares of stock privately or through a public offering to raise funds for expanding the business, meeting obligations, and financing operations. An LLC does not have this flexibility in raising capital.

Management

As a general rule, owners of a corporation do not participate in day-to-day management of the company. In contrast, members of an LLC can choose to manage day-to-day operations themselves or hire a non-member manager to handle some or all of daily management responsibility.

Operational Requirements

Corporations have more legal requirements relating to record keeping, reporting, and holding owner meetings than do LLCs.

Business Losses

For a corporation, business losses are accounted for on the corporation’s tax return. The losses are not passed through to shareholders, so owners do not receive tax benefits when a corporation suffers losses. In contrast, in an LLC, losses are passed through the same as profits, so a member can receive a tax benefit when the LLC experiences losses.

LLCs and Corporations Can Elect Alternative Tax Treatment

The discussion above is based on the standard form of a corporation, which is also sometimes referred to as a “C corporation.” There is another type of corporation called an “S corporation.” When certain requirements are met, a C corporation can become an S corporation by filing an election form with the federal Internal Revenue Service.

Generally, an “S corporation” will not be subject to corporate tax rates. Instead, business profits and losses of an S corporation are passed through to the stockholders, who include the profits and losses on their individual tax returns. As such, filing as an S corporation can avoid the double taxation that occurs for a C corporation. There are specific requirements that apply to an S corporation, including restrictions on ownership.

In addition, members of an LLC can elect to be treated as an entity taxable as a corporation for federal and state tax law purposes.

Which Structure Is Right for Your Business?

Determining which structure is best for your business depends on many factors. How you and others participating in the business wish to be paid and taxed on business profits will be one of the central questions that has to be answered. The nature of the business and your short-term and long-term business goals also need to be taken into account.

Our business attorneys at The Twiford Law Firm have broad experience in business formation and planning as well as a practical understanding of how businesses operate. We will carefully analyze your options and thoroughly talk through all the considerations with you as part of the process of deciding on your business structure.

With offices in Elizabeth City and Moyock, we serve clients throughout northeastern North Carolina. Contact us today at 252-338-4151 or 252-435-2811 to schedule an initial consultation.

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