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Is an LLC a Corporation?

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Published on September 2, 2021

Updated on January 3, 2022

Is an LLC a Corporation?

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Is an LLC a Corporation?

The short answer is no.  A limited liability company (LLC) has similarities to a corporation and to a partnership, but it is also quite different.

An LLC is an increasingly popular business structure for startups, offering liability protection for ownership and greater flexibility than a corporation, particularly in terms of taxes. The LLC itself does not pay taxes. As a “pass-through” entity, income passes through the business to the owner or owners, who report it on their personal tax returns. An LLC is created by filing paperwork with your state, and nominal fees are involved.

What Is a Corporation?

A corporation is a legal business entity that is separate from its owners. Corporations, like individuals, can enter into contracts, pay taxes, hire employees, be involved in legal action, loan or borrow money, and own assets.  Corporations offer personal liability protection for its shareholders, and shareholders benefit from the profits of the corporation. 

Under this structure, the owner or owners are not personally liable for its debts. Owners take profits through shareholder dividends, rather than directly. The corporation pays taxes, and owners pay taxes on their dividends, which is sometimes referred to as double taxation.

A corporation is created when it is incorporated by a single shareholder or group of shareholders who have ownership of the corporation in the form of common stock. A corporation can be for-profit or non-profit.  Shareholders pay money for the common stock but have no further financial responsibilities to the company.

A corporation must have a board of directors, which is responsible for implementing and executing the company’s business plan. The board of directors is elected by the shareholders. 

What Is a Partnership?

A partnership is a business with two or more owners who share the profits and liability of the company. It is possible to have a limited liability partnership, in which one or more owners have some amount of personal liability protection. 

All income goes to the owners, who are also liable for any debts, losses, or liabilities incurred by the business. The owners pay taxes on their share of business income on their personal tax returns. A partnership agreement will define the type of partnership, how profits are shared, and what happens when a partner leaves or when a partner can be forcibly removed.

In a partnership, the company is not taxed.  Profits are passed through to the partners who report them on their personal tax returns.

LLC vs. Corporation

The key difference between an LLC and a corporation is that an LLC is owned by one or more members, while a corporation is owned by its shareholders. Both have limited liability for its owners and shareholders, but corporations are taxed as entities. An LLC can choose to be taxed as either a partnership or corporation. 

An LLC is easier to form and has fewer legal requirements, such as having a board of directors, or annual meetings and reporting.

Let’s look more at the taxes of LLCs and corporations.

In an LLC, the profits of the business are “passed through” to the members and profits and losses are reported on their individual tax returns. The LLC is not taxed, which simplifies things for the members.  Also, losses and operating costs of the business can be deducted personally by the members. Taxes are paid at the personal tax rate of the members, although the owners may also have to pay self-employment taxes.

An LLC may choose to be taxed as corporation, although this is only beneficial in unusual situations.

Corporations are taxed as a separate legal entity from its shareholders. Corporations pay corporate tax on their profits, and tax on dividends distributed to shareholders. While it seems like this is a disadvantage of corporation, there are deductions that can be taken that are only available for corporations.

Also, generally the corporate tax rate is lower than the applicable individual tax rates. If a corporation has fewer than 100 shareholders, it can file to be taxed as an S Corporation which allows the business to be treated as a pass-through entity like an LLC.

An LLC also offers its owner or owners, who are called members, considerable flexibility in terms of management. You can choose your management and operational structure and decide how you want to be taxed. Your LLC can have a single member or multiple members, all of whom have personal liability protection, meaning your personal assets are not at risk if you cannot pay business debts or are involved in a lawsuit.

LLC vs. Partnership

Partnerships are a business relationship between two or more people, while an LLC is a business entity owned by members.  Both are registered with the state in which they do business. A partnership is managed under a partnership agreement, while an LLC has articles of organization and an operating agreement that specifies ownership and roles.

The largest difference between an LLC and a partnership is liability. All LLCs have limited liability protection for members, but not all partnerships do. In a general partnership, all partners are personally liable for the debts of the business and for the actions of other partners. In limited partnerships or limited liability partnerships, which are not available in all states, partners do have some liability protection.

LLCs and partnerships are similar in that they are both “pass through” entities for tax purposes.  In a partnership, each partner receives a K-1 form which specifies their share of profits or losses, which they then report on their personal tax return.

LLCs are not considered a taxing entity by the IRS. LLCs with only one member report their income on a Schedule C with their personal tax returns. LLCs with more than one member are taxed like partnerships, passing through the income or loss to each member. LLCs may apply to be taxed as a corporation or an S corporation, although this is unusual. Partnerships don’t have this option.

Why Choose an LLC?

An LLC is the most common choice for startup companies because it has many benefits. Companies should probably choose an LLC if they want the most flexibility in terms of taxes and management, need to protect their personal assets, and do not need to raise capital from investors. 

Certain types of businesses, however, are not allowed to form as an LLC some states, including insurance agencies and banks. 

The advantages of an LLC are not only the liability protection and the tax advantages, although those advantages are key.  LLCs are also the most flexible with the least amount of paperwork to form, and the least reporting required. They are also less formal, requiring no board of directors or annual meetings. 

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Conclusion

To answer the original question, an LLC is NOT a corporation, but it is a type of business entity. LLCs are more flexible than corporations and partnerships and are easier to form.

An LLC has the limited liability for members just like corporations, as well as the pass-through taxation like partnerships. An LLC offers the best of both worlds, which is why so many startup companies choose to form an LLC rather than a corporation.