Five Differences Between Corporations and Limited Liability Companies

Many of the differences between a corporation and a limited liability company, LLC, concern taxation. Other differences include the degree of liability protection afforded the owners and the variation in state laws regarding the LLC form of business. Some states impose a tax upon LLCs for the privilege of limited liability protection. There may also be other state-imposed costs for the LLC. With the LLC and the corporation, the business entity is separate from the owners leaving personal assets protected from the debt obligations and acts of the business. However, the extent of the protection differs between the two.

Therefore, the first difference between corporations and LLCs concerns the extent of member-shareholder protection from the acts and liabilities of the company. The LLC structure offers less protection to members than the corporation affords its officers, directors and shareholders. Depending on state law, members of an LLC may be held individually liable for acts of employees or to creditors if distributions leave the entity insolvent. The 2010 case of Sturm vs. Harb Development points out that a member of an LLC may potentially be held personally liable for fraudulent acts, negligence and misrepresentation.

A second difference is that a corporation, sometimes called a C Corp, is taxed as an entity at corporate rates. The distributions of earnings to shareholders, in the form of dividends, are again taxed at the shareholders’ individual rates. For the LLC, which is designated as an S-corporation, partnership or sole proprietorship, the company’s earnings are taxed only on the individual returns of the owners. However, unlike the dividends of a C Corp, the earnings are subject to self-employment taxes.

Thirdly, a C Corp is taxed as a corporation and files IRS Form 1120 each year. Conversely, knowing that a company is an LLC leaves one guessing about its tax treatment. There are certain IRS default classifications. An LLC with more than one member is defaulted to a partnership classification. If the LLC is a sole proprietorship, it is viewed as a “disregarded entity” by the IRS, and the taxpayer will file Schedule C with the individual income tax return. The LLC can elect out of its default classification by filing the appropriate IRS forms. The members may choose to have the LLC treated as an S-corporation, if it meets requirements, and an LLC may even be taxed as a corporation.

However, and fourthly, an LLC is not an incorporated entity. There is no state requirement that it hold annual directors’ meetings. In fact, there is no requirement that there even be a board of directors or officers. On the other hand, laws governing C Corps are well established and reasonably consistent throughout the states. Therefore, it is important to detail in the ownership agreement how the LLC will be governed.

Finally, the C Corp directors determine whether to declare a dividend. For an LLC partnership, the distribution of earnings can be determined by the partnership agreement. Distributions need not be in the same proportion as ownership percentages. In some cases, members in partnership LLCs can be limited partners. This means that the income from the partnership is considered passive income. Any passive losses that flow to the members’ individual returns can only offset other passive income such as rental or royalty income. These losses cannot be used to offset non-passive income such as wages.

For more information, consult appropriate professionals when choosing and forming a business structure. These professionals can include a corporate attorney as well as a certified public accountant knowledgeable of corporate, partnership and S-corporation taxation.