The Difference Between an LLC and a Corporation
One question that I constantly hear is: What is the difference between a corporation and an LLC (Limited Liability Company)? This is not easy to answer because there are a lot of differences! Below are some of the most important differences.
One major difference is the law that created and governs them. Corporations and LLCs are artificial entities that are creatures of statute. They only exist because a statute authorized their creation and specified their characteristics and features. Each state has its own statute that governs corporations and, usually, a separate statute that governs LLCs.
In Massachusetts, the statute for LLCs is M.G.L. c.156C, the Massachusetts Limited Liability Company Act (the “Act”) For business corporations, the statute is generally, M.G.L. c.156D, the Massachusetts Business Corporation Act (“MBCA”). But different statutes govern certain corporations (such as professional corporations, non-profit corporations and benefit corporations) and these corporations have different characteristics and features.
Aside from statutory law, there is a significant difference in the quantity and extent of judicially created case-law. Corporations have existed in Massachusetts since 1903 in their current form, although the statute has changed. As such, many questions about corporations and the duties and rights of officers, directors and shareholders have been litigated and answered.
LLCs, on the other hand, have only existed in Massachusetts since 1996 (and elsewhere since 1978) and there is little relevant case law in Massachusetts or other states. Thus, many potential issues are still unresolved and there is uncertainty about how a court will interpret the Act.
Another difference between an LLC and a corporation is how they are formed.
Forming an LLC in Massachusetts basically takes two steps. First, a Certificate of Organization (“Certificate”) must be completed and executed by an authorized person. See M.G.L. c. 156C Sect.12(a) The Certificate is the charter document of the LLC and consists of 9 sections that contain important information about the LLC:
- The exact Name off the LLC;
- The street address of its principal office in Massachusetts and where its records will be maintained;
- A Statement about the general character of the business;
- Latest Date of dissolution, if specified;
- Name and address of Registered Agent;
- Address and name of each Manager, if any ;
- Name and address of each person, in addition to the manager, authorized to execute documents filed with the Secretary of the Commonwealth of Massachusetts (“Secretary”);
- Address and name of each person; authorized to execute and record any recordable instrument purporting to transfer an interest in real property;
- Any other information.
Second, the executed Certificate must be filed with the Secretary, along with the filing fee (currently $500.00 + an additional fee for expedited processing by fax or electronic submission). The LLC exists after both steps are completed and nothing else needs to be done.
Best practices, however, dictate that the LLC and its owners (called the “members”) take additional precautions to reduce the risk of future troubles. An important one is that the members adopt an operating agreement that sets out, among other things, the rights and duties of the members and how the LLC will be managed. Although not required, there are many reasons why an LLC should have an operating agreement, but that is a topic for another day. Consult with your business lawyer to determine what else should be done to minimize your personal liability in connection with the operation of your LLC.
It is a little more complicated to form a corporation in Massachusetts. First, one or more persons (the “incorporator”) must prepare, complete, and execute Articles of Organization (“Articles”) for the corporation. See M.G.L. c. 156D Sect. 2.01. The Articles are the charter document for every corporation and consist of eight (8) articles:
- Article I Exact Name of Corporation
- Article II Limited Purpose of Corporation
- Article III Total Number of Shares and Par Value
- Article IV Preferences, Limitations and Relative Rights of Classes and Series of Shares
- Article V Restrictions on Transfer of Shares, if any
- Article VI Other Lawful Provisions.
- Article VII Effective Date of Corporation
- Article VIII Supplemental Information regarding the corporation, such as name and address for registered Agent, initial directors, president, treasurer and secretary, the fiscal year of the corporation, address for principal office of the corporation and where its records will be kept.
Second, the executed Articles must be delivered by the incorporator to the Secretary and pay the filing fees , which are currently $275.00 (for up to 275,000 shares) + an additional fee for expedited process by fax or electronic submission.
Third, bylaws for the corporation should be created by the incorporator or the initial directors. See M.G.L. c.156D Section 2.05 and Section 2.06 The Bylaws contain essential provisions for managing and regulating the affairs of the corporation. They should include provisions regarding shareholder and director meetings, election and duties of directors and officers, indemnification, voting rights and rules, and other important information.
Fourth, an initial organization meeting should be held by the incorporator or the initial directors identified in the Articles. See M.G.L. c. 156D Section 2.05. At this initial organizational meeting, the initial directors or the incorporator should vote on and approve the following actions: (a) Adopting the initial bylaws just created and (b) Electing or appointing the President, Treasurer, and Secretary identified in the Articles. If the incorporator holds the organization meeting, the incorporator should also elect/appoint the initial directors identified in the Articles. If the initial directors in the Articles hold the initial organizational meeting, they should also take the next step identified below. Keep minutes of all votes and actions approved at the initial organizational meeting, or approve the actions by written consent in lieu of an organizational meeting.
Fifth, the directors should also hold a meeting (which can be the initial organizational meeting if held by the initial directors) to vote on and approve the following actions: (a) ratify all actions taken by the incorporator; (b) Elect additional officers (if desired); (c) adopt a share certificate form; (d) issue shares and approve consideration received for the shares; (e) set the corporation’s fiscal year; (f) authorize other actions needed for operating the corporation (such as obtaining bank accounts, obtaining EIN, etc.). Keep minutes of all actions approved by the directors at this meeting or approve the actions by written consent in lieu of a director’s meeting.
The corporation is properly formed and exists in Massachusetts after these steps are taken. Like the LLC, however, best practices dictate that the corporation and directors should take additional precautions to reduce the risk of future troubles. Precautions can include adopting a shareholder agreement and requiring all shareholders to sign these agreements. Consult with your business attorney to discuss best practices to consider.
Organization and Management Structure
Another important difference between an LLC and a corporation is their organization and management structure.
Corporations have a very rigid organizational and management structure under M.G.L. c.156D. Unless shareholders adopt an agreement pursuant to M.G.L. c.156D Section 7.32 (which not many do), every corporation must have a Board of Directors. See M.G.L. c.156D Section 8.01 and M.G.L. c. 156D Section 8.40. The Board of Directors is responsible for managing the business and affairs of the corporation and exercising or authorizing the use of all corporate power. Directors are elected/appointed by shareholders (or the Incorporator before there are shareholders) and should consist of not less than three (3) individuals, unless the Articles provide otherwise. See M.G.L. c.156D Section 8.03.
Additionally, every corporation must have at least three officers: A President, Treasurer, and Secretary, although one individual can hold all three offices. See M.G.L. c.156D 8.40. A corporation can have other officers, but these other officers are optional. Id. Chapter 156D does not specify who appoints the required officers, but most Bylaws authorize the Board of Directors to appoint officers. Some Bylaws, however, authorize a specified officer, such as the President, to appoint other officers. The familiarity and predictability of this structure appeals to many businesses as the roles of everyone participating in the business are clearly defined and understood.
LLCs have significant flexibility in their management structure. The default rule under the Act is that management is “vested in its members,” unless “otherwise provided in the operating agreement.” See M.G.L. c.156 Section 24. Thus, by default, an LLC that does not have an operating agreement is managed by its members.
But, if the LLC has an operating agreement, the members can choose how the LLC should be organized and managed. The first choice is whether the LLC is going to be member-managed or manager-managed. But once this choice is made, there are lots of other options, such as whether the LLC will be managed by one or more individuals, or like a general partnership, limited partnership, corporation, or something completely unique to the LLC. It all depends on what the members want and agree to in the operating agreement. This flexibility is attractive to many businesses, since they can choose how they want to be managed and delegate power and authority appropriately.
Generally speaking, a corporation and an LLC are also taxed differently at the state and federal level. This issue is complicated so consult with your business attorney and accountant and the wrong choice can lead to disastrous tax consequences. Especially if you plan to work in the business and want to minimize self-employment taxes.
A corporation has two options:
A corporation can be taxed as a “C” corporation, which refers to the applicable sub-chapter of the Internal Revenue Code (IRC). This is the default taxation status for corporations. C corporations are subject to two levels of tax (“Double Taxation”). The first level is at the entity level where the C Corporation pays tax on all taxable income at the applicable corporate rate. The second level is at the individual shareholder level and each shareholder is taxed for any dividends or distributions received from the corporation at the shareholder’s tax rate. Double Taxation is often considered one of the most undesirable features of a C corporation.
A corporation can also be taxed as an “S” Corporation (by filing the appropriate form), which refers to the applicable sub-chapter of the IRC An S corporation is not subject to Double Taxation but has pass-through tax status. This means that the entity is not taxed but its owners are taxed at their individual tax rates as if the corporation’s items of income, loss, deduction and credit were earned or incurred directly by them.
Many business owners prefer pass-through tax treatment. But a corporation must meet certain requirements to qualify as an S corporation. These requirements include not having more than 100 shareholders (which cannot be nonresident aliens, partnerships, LLCs, corporations or most trusts) and only having one class of shares. See https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations. Many businesses have trouble meeting these requirements (or don’t want to) and cannot qualify as an “S” corporation.
Under Massachusetts law, M.G.L. c. 63, corporations are subject to a corporate excise tax of at least $456 per year. But Massachusetts law treats S corporations and C corporations differently, so consult with your accountant or tax adviser to understand the differences.
LLC taxation is more complicated because of the federal Check-the-Box Regulations. Under the Check-the-Box Regulations, each LLC has a default tax classification from the IRS but can choose to be taxed differently. For example, the default tax classification for a single-member LLC is as a Disregarded Entity, which means taxation as a sole proprietorship (for individuals) at the individual tax rate of the individual member. The default tax classification for a multi-member LLC is as a partnership. But in either case, the LLC can choose to be taxed as a corporation (either C or S) by filing the appropriate form.
Massachusetts will generally follow the federal tax classification for an LLC. Generally speaking, LLC’s do not pay the corporate excise tax, unless the LLC elects to be taxed as a corporation.
Formal Requirements and Ongoing Maintenance
Another significant difference between a corporation and an LLC is the formal requirements to properly maintain and operate both entities. Compliance with these formal and ongoing maintenance requirements is critical for ensuring that a corporation or an LLC works properly as a liability shield for your personal assets.
LLC Formal Requirements
LLCs have few formal requirements. Most notably, LLCs must file an annual report each year with the Secretary of the Commonwealth and must keep and maintain the books and records required by M.G.L. 156C Section 9. That’s it!
Best practices, however, dictate that an LLC take additional precautions to ensure that it has a separate existence and protects your assets. These include, but are not limited to, having adequate capitalization, opening a separate bank account, creating customer contracts, acquiring insurance, paying all bills in the name of the LLC (rather than the name of the members), and other appropriate precautions. Consult with your business attorney to discuss.
Corporation Formal Requirements
Corporations, on the other hand, must follow numerous formal requirements. Some of the most notable include: hold regular shareholder meetings (at least annually); hold regular Board of Director meetings (at least annually) and in connection with all major decisions affecting the corporation; keep accurate minutes of all shareholder and/or director meetings; maintain other appropriate books and records; cile an annual report with the Secretary, and others. Additionally, a corporation should take the same precautions identified above in connection with the LLC, such as opening a bank account, creating customer contracts, etc.
For many business owners, the ongoing formal requirements for a corporation seem overwhelming and causes them to choose an LLC. But these requirements can be easily managed and should not be the sole reason for choosing an LLC as opposed to a corporation.
Choosing between an LLC and a corporation is a big decision for every business. There are a lot of factors to evaluate and consider. Consult with a knowledgeable business formation lawyer and your accountant before choosing one or the other.