Is an LLC a Corporation or Sole Proprietorship?

A limited liability company (LLC) is one of the most popular business structures, and its flexible nature means that it can elect to be taxed in several different ways:

• As a corporation (i.e., C corp and S corp)
• As a sole proprietorship
• As a general partnership

This can make starting business owners slightly confused about the exact legal classification of LLCs.

So, is an LLC a corporation or sole proprietorship? Because it’s a hybrid structure, the answer is “both” and “neither.”

What Are Sole Proprietorships, Corporations, and LLCs?

Each business structure comes with different advantages and disadvantages. These commonly relate to the financial, managerial, and tax-related aspects of a business.

Sole Proprietorships

A sole proprietorship is one of the most simple (and popular) business structures. It allows owners to retain ultimate control over the way that their business is managed and is subject to a very small amount of government scrutiny. 

Even if you do not register as a sole proprietorship, if you engage in certain types of business activities (e.g., as a freelancer or independent contractor), you may automatically be considered to operate a sole proprietorship according to the Internal Revenue Service (IRS). This means that you could own a sole proprietorship without even knowing it. 

A sole proprietorship is not considered to be a separate legal entity to its owner(s). Therefore, sole proprietors are not privy to the benefits that are enjoyed through the corporate veil, such as limited personal liability, the ability to register as a company employee, and the ability to make increased tax deductions

This means that owners of a sole proprietorship will remain personally liable for any debt or liability that their business accrues. 

Sole proprietorships are also commonly viewed as less “credible” by common financiers (e.g., banks, credit card companies, etc.). Since they are also unable to sell stock, obtaining funding is generally much less accessible for them.

Since a sole proprietorship is not considered to be a separate financial entity to its owner(s), it is not subjected to “double taxation.” Instead, a sole proprietorship’s profits are considered to be its owners’ profits, which are taxed on an individual level (personal tax returns).

The benefits of a sole proprietorship include:

• Simple and inexpensive formation
• Full control over the way the business is managed (i.e., no IRS requirements)
• Straightforward tax structure

The disadvantages of a sole proprietorship include:

• No limited liability
• Fewer funding options
• Less credible brand image

Corporations

C Corporation (C Corp)

A C corporation is an entirely separate legal entity to its owner(s). This means that it can generate a profit, be found liable under a court, and be taxed separately from its owners.

The benefits of such a structure include:

• Limited personal liability for shareholders
• Increased credibility
• Increased access to funding
• Increased ability to make tax deductions
• Easier transfer of ownership: This is because it exists indefinitely regardless of the fate(s) of its owner(s)
• Ability to register as an employee of the corporation

On the other hand, C corps do come with a few drawbacks:

Double Taxation

C corp shareholders are taxed twice on the same stream of revenue. Once at a corporate level (21%), and a second time at the shareholders’ personal tax returns. 

Despite this, the financial benefits of increased tax write-offs, employee-registration benefits, and increased financing opportunities can make C corps an ideal choice for medium- to large-scale businesses. 

Increased Government Scrutiny

C corps have to comply with a lot more regulations than their unincorporated counterparts. For example, they are legally required to have (and record) annual meetings with the company’s shareholders and board of directors.

Complex and Costlier Formation
Unlike sole proprietorships, in order to register your business as a C corp, you will need to satisfy numerous legal and filing requirements. There are also additional fees involved (especially if you choose to hire an attorney or tax consultant.)

While these may not be the “end of the world” for already established businesses, they may dissuade smaller businesses whose financial benefits may not outweigh the initial startup cost of registering as C corps

S Corporation (S Corp)

An S corp is not quite a business structure; it is an IRS tax status designed to allow the owners of LLCs and corporations to avoid paying “double taxation.” This is done by passing the S corp’s profits through to its owners without needing to pay any corporate tax. 

At the same time, owners of S corps maintain limited liability under the law. 

Even though this may seem like a better choice to the C corp, the reality of the situation is not so simple. Companies need to satisfy specific requirements in order to be eligible to elect S corp status. 

These can vary significantly depending on your state, with some refusing to recognize S corp status altogether. 

In order to be eligible to elect S corp status, a corporation must:

• Be a domestic corporation
• Have no more than 100 shareholders
• Only have “allowable owners”: These include individuals, certain trusts, and estates
• Have only one class of stock
• Not be an ineligible corporation (e.g., insurance companies or financial institutions)

If you are interested in becoming an S Corporation, you will need to file Form 2553 (Election by a Small Business Corporation) after it has been signed by all your company’s shareholders. 

Further instructions can be found on the IRS website.

Benefit Corporation (B Corp)

A B corp is virtually identical to a C corp when it comes to limited personal liability and taxation. They are, however, quite different when considering their purpose and structural transparency. 

In addition to operating for profit, B corps must show that they are advancing a certain “mission” or cause that generates public benefit. 

Depending on your state, you may be required to submit annual “benefit reports” in order to demonstrate this if you want to operate as a B corp.

The benefits of registering as a B corp are generally non-financial:

• Facilitate social advancement
• Attract employees of a similar ethos to yourself
• Obtain access to the B corp community data

Not every state offers the benefit corporation structure. If you want to register your company as a B corp, you will need to amend your Articles of Incorporation and bylaws to reflect this, and the process is generally quite straightforward.

Certified B Corps

A Certified B Corp is a corporation that becomes certified by the third-party organization B Lab. You typically don’t have to be a benefit corporation to become a Certified B Corp (or vice versa), but it may provide extra transparency.

If you want to become a Certified B Corp under B Lab, there are three main steps that you will need to satisfy:

1. Take and score over 80 on the B Impact Rating System (you will be updated via a telephone interview.)
2. Adopt a B Corp framework within your company
3. Fill in and sign a Term Sheet that “certifies” your B Corp status officially

Close Corporation

A close corporation is an incorporated business entity that:

• Is not publicly traded
• Does not exceed the statutory limit on the number of shareholders allowed (usually 35).

This type of corporation can usually be run without an official board of directors and is not subject to the same level of regulatory scrutiny that C corps experience. For example, they are not required to hold or record annual meetings. 

By default, the shareholders of a close corporation retain the same personal liability that they would under a general partnership. 

When they step in and participate in the active management of the business, however, they retain their limited personal liability under the law in exchange for having to comply with the fiduciary duties of a corporation’s directors. 

The benefits of a close corporation include:

• Greater shareholder control
• Less government scrutiny
• Increased management flexibility

LLCs

An LLC is a hybrid structure that allows business owners to enjoy the managerial and structural flexibility of a sole proprietorship while maintaining many incorporated benefits.

Moreover, LLCs are extremely flexible when it comes to how they can be taxed. Subject to their owners’ eligibility, they have three options for tax structures:

• Disregarded Entity (i.e., sole proprietorship) — Default status for single-member LLCs
• Partnership — Default status for multi-member LLCs
• C Corporation
• S Corporation

Consequently, the answer to the question “Is an LLC a corporation or sole proprietorship” can be confusing. From a tax point of view, an LLC can elect to be categorized as either business entity, meaning it could be treated as both.

On the other hand, its general flexibility, popularity, and unique ability to benefit from a generally low amount of government scrutiny while maintaining incorporated benefits likely places it in a category of its own (i.e., neither).

Is an LLC Right for My Small Business?

Whether an LLC business structure is right for your business will be dependent on several different factors.

These include your:

• Industry
• Available capital
• Management style
• Future goals

All in all, you will need to consider whether the benefits of an LLC (e.g., no double taxation, less paperwork, limited personal liability, etc.) are going to be significant when accounting for your business’s current size.

Generally speaking, LLCs can be great for small businesses because:

• Their increased flexibility can “keep doors open” in the future
• They allow business owners to not have to jeopardize their own personal assets
• They can be formed quite quickly (especially when relying on specialized LLC formation services)

How Do I Register as an LLC?

Registering as an LLC can be quite simple. Generally speaking, you should follow these steps:

• Check your state’s filing requirements: These can vary significantly from state to state, so it is important that you read up on your state’s specific mandates before you begin your registration process
• Check your profession’s eligibility: Certain professions are not eligible for LLC status in some states (e.g., lawyers and doctors). This is because legislators have argued that such professionals should not be privy to limited personal liability since the nature of their work requires them to exercise an exceptionally high degree of care.
• Choose a registered agent: LLCs are required to have a registered agent and/or registered office. This can be themselves, another qualified individual or entity, or a registered agent service.
• File your Articles of Organization: This can vary depending on your location but will generally include:
  • The name of your LLC
  • Your registered agent’s information
  • Your LLC’s effective date and lifespan
  • The names and addresses of your members or managers
• Create your operating agreement: This should include:
  • How your LLC will distribute profits
  • How your LLC will be managed on a day-to-day basis
  • How decisions will be finalized
  • The ownership percentages in your LLC
  • What happens if an owner wants to dissolve the LLC
  • What happens if an owner wants to exit

For more information, check out our state-specific How to Start an LLC guides.

Frequently Asked Questions