Estimated reading time: 10 minutes
Table of contents
- What is a LLC?
- What is a Corporation (Inc.)
- What do LLC and Inc have in common?
- Incorporated vs LLC ownership
- Inc. vs LLC: Maintenance and Requirements
- LLC vs Inc: Profits and Losses
- LLC vs Corporation (Inc.): How are they formed?
- The Benefits of Incorporation
- Corporation (Inc.) vs LLC: Which should you choose?
If you’ve ever considered starting a business, then you know that selecting the type of business entity can be very confusing. When you’re new to entrepreneurship, it can feel overwhelming as you research and try to understand entity structures. And while there are many entity options, it usually comes down to LLC vs. Inc. (Corporation). So, the burning question is… What is the difference between an LLC and a corporation?
Let’s take a moment to explore the differences between LLC and corporation (or Inc.) and the benefits you can get from each structure, including the disadvantages and advantages.
Selecting the correct business entity is your giant first step to becoming a business owner. It’s the bedrock on which you’ll build your start-up–your platform for growth.
Your choice between LLC or corporation will help you set the stage for how your business functions on a daily basis, as well as how it expands over time. As you research your decision, start thinking about the protection you want and the advantages you need to be successful.
So, what are the differences between LLC and Inc? Let’s find out!
What is a LLC?
A Limited Liability Company (or LLC) is just that – it protects you, as the business owner, from being held personally liable for the actions of your business (or the LLC). If there is a lawsuit against your business (and in our lawsuit happy country, this is bound to happen at some point), the LLC protects you from the personal risks. This means that your personal assets stay safe. Additionally, LLCs have other benefits.
- LLCs offer pass-through taxation, meaning that taxes are not paid at the business level. When you create an LLC, income and losses are reported to the IRS on your personal tax return. When taxes are due, they are paid on the individual level.
- LLCs provide flexible management structures, allowing you to take control of daily operations and long-term growth strategies. Corporations have a predetermined management structure where directors supervise the essential business decisions, while officers take on running daily functions of the business.
- LLCs face fewer compliance requirements than corporations, as well as fewer state-imposed annual requirements and ongoing formalities.
With all of the great benefits of an LLC, there are still some disadvantages to explore, as well.
- LLCs have higher ongoing expenses through state filing fees, annual report and/or franchise tax fees, and some states even require owners to publish notice of the LLC formation in the local newspaper.
- Ownership is more difficult to transfer in an LLC, since typically all owners must approve the changes or ownership addition. Corporations utilize shares of stock to manage ownership.
- Because LLCs are a newer type of business structure, there is less legal precedent for this entity type.
What is a Corporation (Inc.)
When you form a corporation, you business becomes “incorporated”. You’ve probably seen business names with an Inc. at the end…well that’s a business that’s been structured as a corporation. In the same way you’ve probably seen a company with an LLC after it’s name. So, in reality, your choice is really LLC vs. Inc…incorporated vs LLC.
We already explained what LLC means (and the benefits that go along with it), but what does Inc mean and what are its benefits?
The most important difference between LLC and corporations is the tax structure. S-corporations operate like an LLC with pass-through taxes. However, C-corporations are taxed separately, and also subject to double taxation if corporate profits are distributed to owners as dividends.
This is why many people opt for forming an LLC over a C corp and even an S corp.
C-corporations pay taxes through their profits as a corporation and then individual owners pay taxes separately on profits received as dividends. This tax that is paid on two levels, is referred to as double taxation.
There are additional useful differences to note regarding these two entity structures:
- S-corporations have restrictions regarding the number of owners, the type of owners, and who/what can own it.
- C-corporations give owners the ability to hold different types of stock interests, providing various levels of dividend payouts.
- If you incur business losses, S-corporations allow owners to use the losses as deductions on personal tax returns.
- S-corporations can help save money on self-employment or Social Security/Medicare taxes. Owners have the ability to offset non-business income with losses from the business.
What do LLC and Inc have in common?
In the above section we answered the question “what’s the difference between LLC and Inc.”. Now, let’s quickly look at what they have in common.
The main commonality is that both corporations and LLCs limit the personal liability of the owners/shareholders from the debts of the business and against lawsuits against the business.
But while both structures start protecting business owners from day one, both business types must work to keep their operations separate from the activity of the owners to maintain their personal liability protection.
This is known as the “corporate veil,” meaning that there is a separation between the liability of the business and the liability of the owners. If a court finds that the operations are not separate, the owners or shareholders can be personally liable for the actions or debts of the business. On a side note, there are some states where piercing the corporate veil is a lot more difficult, making them popular destinations for LLCs and corporations. Delaware and Nevada are two such states.
Some people think that an LLC offer’s less protection against liability, but that’s simply not true.
Here are some other similarities:
Pass-through taxation. Both LLCs and corporations (if set up as an S corp) can be pass-through tax entities, meaning no income taxes are paid at the business level. Business profit or loss is passed-through to owners’ personal tax returns. Any necessary tax is reported and paid to the IRS at the individual level.
Ongoing state requirements. Both are subject to state-mandated formalities, such as filing annual reports and paying the necessary fees.
Incorporated vs LLC ownership
While LLC’s and corporations both have owners, the form of ownership looks a little different.
An LLC is formed by individuals (members) who have an equity (ownership) interest in the assets of the business. Owner’s Equity is defined as the proportion of the total value of a company’s assets that can be claimed by its owners. This means that the owners of an LLC made an investment to join the business.
Corporate owners, on the other hand, are shareholders or stockholders. They have shares of stock in the business. A shareholder can be an individual, company, or trust that own shares of a for-profit corporation. These individuals (owners) own a specific number of shares, which they each purchased at a specific price.
Inc. vs LLC: Maintenance and Requirements
Differences in management, existence, transfer-ability of ownership and self- employment taxes exists between both entity structures. LLCs are recommended, but not required, to follow internal formalities, while S corporations face more extensive internal formalities.
Additionally, for an S corp to elect S corp status, there are certain qualification it must meet and maintain. To qualify for S Corp status, your business:
- Must be a domestic corporation formed in the U.S.A.
- May have no more than 75 shareholders.
- May only have individuals, estates, or certain trusts as shareholders.
- May not have non-resident alien shareholders.
- May only have one class of stock.
- Must be a small business corporation, financial institutions (i.e. banks, insurance companies, building and loan associations, mutual savings, and loan associations) cannot take advantage of an S corporation election.
- Must conform to state statutory restrictions, which limit the transfer of shares/ownership of the company.
LLC vs Inc: Profits and Losses
LLCs as Pass-through Businesses
LLC’s, like partnerships and sole proprietorships, are pass-through entities. Pass-through is a fancy way of saying that the profits and losses of the business “pass through” to the owners or shareholders. The owners pay their share of the company’s profits on their personal tax return.
Corporations as Separate Business Entities
While S-Corps have pass-through taxation, C-Corps are not and face the risk of being taxed twice (double taxation) on corporate earnings.
The corporation pays income taxes on its profits or losses, not by the owners directly. Some of the corporation’s earnings may be paid to the owners in dividends, but this isn’t direct. Some earnings may be kept by the corporation.
LLC vs Corporation (Inc.): How are they formed?
Forming an LLC
An LLC is formed by one or more business people. The owners (otherwise known as “members)”, file Articles of Organization with a state. Once that’s complete, they put together a contract called an Operating Agreement to use in managing the day-to-day activities and decide on each member’s percentage share of ownership, roles and responsibilities. Operating Agreements are required for LLCs but they’re strongly suggested
Forming a Corporation
A corporation is formed (or incorporated) by filing corporate organization documents called Articles of Incorporation in the state where the corporation is located. Additionally, the corporation must create a Board of Directors to oversee the business. The board is then required to agree on bylaws (same thing as an operating agreement).
The Benefits of Incorporation
In our litigious society, incorporating to protect yourself just makes sense. No other structure gives you and your business the liability protection offered by incorporation. When you incorporate, your personal assets are not at risk for the debts and liability of your business.
It doesn’t take a catastrophic lawsuit to wipe out everything you own. Could you satisfy all your business obligations without tapping into personal reserves or losing personal assets? Incorporating takes this burden off your shoulders knowing that your personal assets cannot be targeted in the event of a business lawsuit.
There are a ton of tax benefits that come with incorporation. LLCs and corporations are entitled by law to many tax deductions not afforded to individuals. Additionally, the self-employment tax savings alone can amount to thousands of dollars saved every year.
Corporation (Inc.) vs LLC: Which should you choose?
It can be difficult to decide the best entity for your business–especially when the differences could spell success or disaster for your business.
Doing your research ahead of time can definitely help you make an educated decision, but it’s important to also seek expert advice so you start your business on the right path to success.
Lucky for you, Inc Authority is chock full of business formation experts who can walk you through these important differences and help you make the best possible decision for your business.
Incorporating is the most powerful thing you can do to legitimize your startup. And at IncAuthority.com, our setup LLC services are 100% free. Always. So, don’t wait. Form your new LLC today and enjoy the protection due to you and your business under the law.
The main advantage of forming an LLC is to limit personal liability because LLCs have their own existence. Other advantages of an LLC include the following:
• LLCs can be governed informally. They do not require a board of directors, meetings, quorums, minute keeping, and other management formalities.
• LLCs have flexibility in deciding how to split their financial interests. An LLC can distribute its income to each member equally, based on his or her capital contributions, or in many other ways.
• An LLC can be a pass-through tax entity without the restrictions that are imposed on corporations.
The disadvantages include the following:
• LLC members can’t pay themselves wages.
• Some states charge a franchise or capital values tax on LLCs. This fee can be a flat fee or a fee based on the revenues of a company.
• Some LLCs have difficulty raising capital because investors tend to put their money into corporations.
• Some banks are hesitant to give loans to LLCs because of high turnover rates and smaller assets.