Which is Better: Corporation
or Limited Liability Company (LLC)?

Which is better: Corporation or Limited Liability Company (LLC)?

When deciding between a Corporation or Limited Liability Company (LLC), which is better? A Limited Liability Company has significant flexibility in the areas of ownership and taxation, while simultaneously providing benefits that were original unique to corporations, including limited personal liability and unlimited life.

Essentially, LLC's are the best of two worlds.

The biggest attraction of an LLC is having limited personal liability without all the undesired features of a corporation. In a partnership, which has unlimited liability, if the company owes a million dollars, then the owners are responsible for that amount. However, LLC's and Corporations are both considered to be legal entities separate from their owners. The most that any one owner can lose is the amount he or she has invested in the company; so if the company owes a million dollars, and one owner has invested $10,000, then the most that this owner can lose in the event of bankruptcy is $10,000.

Furthermore, to an extent, LLC's can choose how they are taxed. If the LLC only has one owner, then the government will generally tax the company as a sole proprietorship. However, if the company has anywhere from 2 to 100 owners then the business can choose to be taxed as a partnership OR claim "S Corporation" status.

Flexibility of Taxation for Limited Liability Company (LLC)

Revenue earned by a partnership is taxed only once, but owners are subject to the extra Self-Employment Tax (SECA Tax) on all revenue. Conversely, revenue earned by a corporation is typically taxed twice. First, the revenue earned by the company is taxed, since the corporation is treated like a separate entity, and then any money distributed to owners as dividends is taxed a second time as individual income. However, the benefit of being taxed like a corporation is that it avoids some of the extra Self-Employment Tax, because dividends are considered to be "unearned" income.

Self-Employed individuals are taxed about double for Social Security and Medicare than those who are considered employees of a company.

The "S Corporation" status is a combination of these two classifications, where income is taxed only once AND owners can designate some income as salary (i.e. "earned" income) and some as dividends (i.e. "unearned" income). As mentioned, dividend income is not subject to the SECA tax.

In addition to all these benefits of LLC's, there is less government regulation involved with LLC's, which means less forms and less rules. However, there are still reasons why a company may choose to become incorporated.

Why Choose Corporation?

With the flexibility of a Limited Liability Company (LLC), one may wonder why any company would still choose to become a corporation. The primary reasons to become incorporated are:

  1. Corporations find it much easier to obtain large amounts of financing,
  2. Personal liability is reduced with more shareholders,
  3. Ownership is transferred more easily than in LLC's, and
  4. Being taxed as a corporation is typically better when revenue earned is significant due to avoidance of the Self-Employed SECA tax on all income.

Furthermore, for tax purposes, any LLC with more than 100 shareholders is automatically taxed as a corporation, even if the company is legally a LLC. So if the owners of a company intend to grow their business into a significant enterprise, then a corporation is likely the best business classification to pursue.

It is also important to note that when a business becomes incorporated for the first time, it often earns significant funds from the first sale of shares of the company. The business is essentially giving people ownership rights in exchange for their money, which can generate millions of dollars for an already established company.

In addition, whenever the company needs to raise funds in the future, creating and selling additional shares of the company is an option only available to Corporations.

Investor Response to New Public Offerings of Ownership

It is important to mention that investors often consider it to be a negative event when an already established corporation chooses to raise additional funds via creating and selling new shares of the company.

The reason why is because creating more shares of the company invites more owners to join; which causes personal liability is be further dispersed, but it also means that potential earnings as dividends will also be further dispersed. Therefore, logically speaking, if management of a company has a negative outlook of the company's future, then they might try to further disperse personal liability in order to limit personal risk. However, if the company has a positive outlook, management will likely pursue other financing options in order to keep more earnings for themselves.

At least, this is how investors typically perceive a new public offering for stocks for an already established Corporation. Whether or not this is an accurate deduction of managerial decisions is a separate issue.

Final Verdict: Corporation or LLC?

Overall, whether or not a Corporation or Limited Liability Company (LLC) is better depends on the size of the company and the overall business goals. If the company intends to eventually become a significant enterprise, then incorporation is almost guaranteed to become a necessity. Rapid growth is also a major catalyst for incorporation, due to the initial revenue generated from offering shares of the company as well as the future financing opportunities available only to corporations.

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