LLC vs Corporation

Which Is Best For You?

Key differences you should know between the two entities

Limited liability companies (LLCs) and corporations have many similarities. Both provide their respective owners with liability protection, perpetual existence, added credibility and professionalism, and tax savings.

This webpage focuses on the key differences between an LLC and a Corporation. For more information on LLCs vs S-Corporations, see our side-by-side comparison chart or see a full write-up on our LLC vs S-Corp page.

In Texas, corporations and LLCs have specific differences with regard to raising capital, inside liabilities, adhering to formalities, taxation, and management. The tabs below outline some of these key differences.

raising capital

Raising Capital

Corporations are specifically designed for raising capital (i.e. selling shares of stock). LLCs can raise capital too by selling membership interest.

The c-corporation is the preferred vehicle for publicly held companies. If you desire to go public or obtain venture capital, you will most likely have to convert your entity to a c-corporation.

LLC Liabilities

Liabilities

Corporations and LLCs both provide their respective owners with liability protection from the obligations of the business. One of the advantages of forming an LLC in Texas over a corporation is protection against outside liabilities (i.e. the liabilities of the other members). For example, if a husband and wife each own 50% of an LLC and the husband is sued for a personal obligation, the creditor (assuming they get a judgment and the judgment is not paid by the husband or his insurance) can seize the husband’s non-exempt assets, including the 50% ownership interest in the LLC. If the LLC’s operating agreement is NOT drafted properly, the husband’s creditors would own the LLC with the wife 50/50 and would be entitled to call meetings, vote at meetings, force the sale of LLC assets or the LLC itself. With a properly drafted operating agreement, the husband’s creditor in this situation would only be allowed to take whatever actual cash distributions are authorized by the remaining members of the LLC (which may be zero). The typical corporation does not have this protection from the owner’s creditors. A corporation can have similar protections, but would require a shareholder’s agreement with buy/sell provisions.

Flexibility

The LLC is known for its almost infinite flexibility. This is one of the key differences between the two entities. It’s not that the corporation is inflexible, but rather, the LLC is just very flexible.

Tax Flexibility – An LLC can choose to be taxed as a sole proprietorship, partnership, s-corporation, or c-corporation. A corporation, on the other hand, is taxed as either a c-corporation or s-corporation. Read more about LLC Taxation and Corporate Taxation.

Management Flexibility – A corporation must have directors and officers (i.e. a president and a secretary), while an LLC does not. Compared to a corporation, an LLC has greater flexibility in how it can be managed. The owners of an LLC, called members, can choose their management structure. The members can manage the LLC themselves (member-managed), or designate managers (manager-managed) to govern the LLC (who do not have to be owners of the LLC).

Read more about the different management structures under the “Management” tab above.

Corporate Formalities

Formalities

Although the rules regarding corporate formalities have been relaxed recently, the LLC was specifically designed to be less formal than a corporation. Texas law does not require LLC members or managers to adhere to rigid corporate formalities. However, Texas corporations must follow rigid corporate formalities, such as maintaining written minutes at all meetings involving shareholders and directors, and maintaining records of all books and accounts.

LLC Taxation

Taxation

LLCs – The IRS does not have a specific tax classification for LLCs. As such, an LLC is taxed as one of the following four classifications: (1) sole proprietorship, (2) partnership, (3) s-corporation, or (4) c-corporation. The first two classifications are the most common because no extra paperwork is required. The LLC has the option to be taxed like a corporation, but the corporation does not have the same option. By default (i.e. if no extra paperwork is filed with the IRS), a single-member LLC is taxed as a sole proprietorship and a multi-member LLC is taxed as a partnership.

Corporations – A regular corporation (also known as a c-corporation or c-corp) is subject to corporate taxes and must file tax returns (Form 1120) each year. If, and only if, the shareholders receive a dividend from the corporation, such shareholder would have to pay income tax on the dividend. As you can see, dividends paid to shareholders of a c-corporation are essentially taxed twice. They are taxed once at the corporate level (on the c-corporation’s Form 1120), and again at the shareholder level (on the shareholder’s Form 1040).

Unlike an s-corporation, a shareholder of c-corporation is taxed on dividends only when those dividends are actually paid out. Unlike a c-corporation, an s-corporation is generally not subject to corporate taxes. Specifically, an s-corporation is exempt from federal income tax other than tax on certain capital gains and passive income. The s-corporation is considered a “pass-through” or “flow-through” entity. In other words, the s-corporation’s income (or net losses) passes through the corporation to the shareholders for federal income tax purposes (even if the shareholder does not receive a dividend). The s-corporation’s profits are taxed each year on each shareholder’s Form 1040. It is important to remember that an s-corporation’s shareholders will have to pay taxes on ALL of the s-corporation’s profits event if they do not receive a dime. What is required to become an s-corporation?

Self Employment Taxes – One of the benefits of electing to be taxed as an s-corporation is the potential tax savings related to self-employment taxes (i.e. Social Security and Medicare). A shareholder who is also an employee of the s-corporation (shareholder-employee) only pays self-employment taxes on his or her salary. The remaining profits that are attributable to this same shareholder would NOT be subject to the 15.3% self-employment tax. Let’s assume the s-corporation has one shareholder who is also an employee and the s-corporation has $100,000 in profits in year 1. If the shareholder were also an employee and had a $40,000 salary, the shareholder would only have to pay the 15.3% self-employment tax on the $40,000 salary (not the entire $100,000 in profits). Do not be tempted to pay yourself an unreasonably low salary to avoid self-employment taxes, the IRS has said over and over again that s-corporations must pay their shareholder-employees “reasonable compensation” for services rendered to the business.

For more details, see our articles on LLC taxation and corporate taxation or our side-by-side comparison chart.

Management

A corporation must have directors and officers (i.e. a president and a secretary), while an LLC does not. The owners of a corporation elect directors (sometimes called a board of directors) to govern the corporation. The directors appoint officers to handle the day-to-day activities of the corporation.

Compared to a corporation, an LLC has greater flexibility in how it can be managed. The owners of an LLC, called members, can choose their management structure. The members can manage the LLC themselves (member-managed), or designate managers (manager-managed) to govern the LLC (who do not have to be owners of the LLC).

In a member-managed LLC, each owner has a say in management in accordance with his or her ownership percentage.

A manager-managed LLC resembles a corporation in that the managers are elected by the members to govern the LLC much like a corporation’s directors are elected by its shareholders to govern the corporation. Manager-managed LLCs are appropriate when (a) some of the members are passive investors and don’t want to be involved with management decisions; (b) the founder wants to retain control of the LLC while having other owners share in the profits; or (c) any other reason to have a management team that may not be the same group as the ownership team.