One of the first decisions to make when starting a new business is choosing the type of entity your
business will be. The most common choices are a limited liability company (“LLC”) or a corporation but
choosing between the two significantly impacts how the business is taxed, owned, and managed.
Among other things, consideration should be given to the difference in the formal requirements
between LLCs and corporations.
The ownership structure of an LLC and a corporation are quite different.
Corporations are allowed to issue and sell shares of stock to their owners, called shareholders. The
shareholders are able to transfer shares, purchase more shares, or sell shares. Ownership of a
corporation is beneficial to drive outside investors and capital.
LLCs are allowed much more freedom in their ownership and profit-sharing structure. LLCs are owned
by members who own a percentage of the LLC, called units of membership interest as opposed to stocks
or shares. Typically, the operating agreement of the LLC will direct how profits are apportioned to the
members. The operating agreement also controls how membership can be transferred (if at all) and
what happens when a member desires to leave the LLC.
According to statutes, the management structure of a corporation is fairly strict. Generally,
shareholders, while considered owners of the corporation, make no direct business decisions for the
corporation. Instead, corporations have a board of directors to manage the business. The shareholders
indirectly manage the business by electing directors who sit on the board. The board of directors then
assign corporate officers to handle the day-to-day operations. However, depending on the business's
governing documents, shareholders may be able directly manage the business if they also serve as a
director or officer.
In contrast, LLCs are offered much more flexibility in their management structure. LLCs are allowed to
be actively managed by their members (a “member-managed LLC”), or the members can hire
independent managers who manage the business (a “manager-managed LLC”). The managers may or
may not have an ownership interest in the LLC
One of the most profound differences between an LLC and a corporation is the way they are taxed.
Most LLCs are pass-through entities. This means that the profits (or losses) of the business are “passed
through” to the owners. Generally, the individual owners report profits or losses on their personal tax
returns, while the business itself does not pay any taxes. The entity then, is said to be “disregarded” by
Most corporations, on the other hand, are taxed as a separate legal entity. This means that if the
business earns income, the business itself must pay taxes on that income (sometimes called the
corporate tax). In addition, the shareholders pay taxes on dividends they receive from the business.
Because both the corporation and the shareholders pay taxes, this is called “double taxation.” While double taxation seems unadvisable, there are certain corporate financial benefits that can significantly
offset the taxes.
If the corporation meets certain requirements, the corporation can elect to be taxed as a pass-through
entity. This election is called an “S-Corp election” because the taxation is governed by Chapter S of the
Internal Revenue Code.
The state of Colorado requires different maintenance and reporting actions for corporations versus LLCs.
Generally speaking, the requirements for an LLC are far less rigorous than for a corporation. In addition
to having a board of directors, corporations are generally required to, among other things, hold annual
shareholder meetings and to keep detailed corporate resolutions when changes are made. On the other
hand, LLCs are not automatically required to have a board of directors or hold annual meetings
(although if the LLC has an operating agreement, it may require such actions).
Choosing a business structure is vital to the long-term health of any business. Choosing between a
corporation or an LLC should be made with the advice of a competent business attorney. Burnham Law
can help you with create your new small business today.