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Updated: Oct. 23, 2024
Starting a business comes with many decisions, and choosing the right business entity can be one of the most confusing. As a new entrepreneur, navigating the various business structures may feel overwhelming. While there are several options, the choice often narrows down to a limited liability company (LLC) or a corporation (Inc.). So, what sets these two entities apart?
Let’s examine the key differences between LLCs and corporations and explore the pros and cons of each business structure to help you make an informed decision.
Selecting the correct business entity is your 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 an LLC and a corporation will help you set the stage for how your business functions daily and 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 an LLC and an Inc? Let’s find out!
An LLC is just that – it protects you, as the business owner, from being held personally liable for the actions of your business. 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 potential liability. This means that your personal assets stay safe.
Additionally, LLCs have other benefits.
Although an LLC offers great benefits, it also comes with some disadvantages.
When you form a corporation, the business becomes “incorporated.” You’ve probably seen business names with Inc. at the end, which means they’ve been structured as a corporation. Similarly, some companies have the abbreviation LLC after their names. Ultimately, the decision comes down to choosing between an LLC and a corporation.
We already explained what an LLC means (and the benefits that go along with it), but what does an Inc. mean, and what are its benefits?
The most important difference between LLCs and corporations is the tax structure. S corporations operate like LLCs with pass-through taxes. However, C corporations are taxed separately and are also subject to double taxation if corporate profits are distributed to owners as dividends.
These businesses pay taxes through their profits, and their owners pay taxes separately on profits received as dividends. This is why many people choose to form an LLC over a C or S corporation.
There are additional useful differences to note regarding these two entity structures:
In the sections above, we answered the question, “What’s the difference between an LLC and an Inc.?” Now, let’s quickly look at what they have in common.
The main commonality is that corporations and LLCs reduce an owner or shareholder’s liability for their incurred debts and lawsuits. Still, while both structures start protecting business owners from day one, they must work to keep their operations separate from their owners to maintain personal liability protection. This is known as the “corporate veil,” meaning that there is a separation between business and personal liability.
If a court finds that business operations aren’t separate, owners or shareholders can be held liable for their company’s actions or debts. On a side note, piercing the corporate veil is more challenging in some states, making those areas popular destinations for LLCs and corporations. Delaware and Nevada are two such states.
Some people think an LLC offers less protection against liability, but the opposite holds true.
LLCs and corporations also share the following characteristics:
While LLCs and corporations have owners, the form of ownership looks a little different.
An LLC is formed by individuals (members) with an equity (ownership) interest in the firm’s assets. Owner’s equity is defined as the proportion of the total value of a company’s assets that its owners can claim. This means LLC owners made an investment to join the business.
Corporate owners, on the other hand, are shareholders or stockholders. They own shares of stock in the business. A shareholder can be an individual, company, or trust that owns shares of a for-profit corporation. These individuals (owners) own a specific number of shares, which each shareholder purchased at a specific price.
Differences in management, existence, transferability of ownership, and self-employment taxes exist between both business structures.
LLCs are advised, but not required, to follow internal formalities outlined in an operating agreement. Meanwhile, S corporations face more extensive internal formalities.
Additionally, for an S corporation to elect the status, it must meet and maintain certain qualifications. To qualify for S-corp status, your business must:
LLCs and corporations also manage their profits and losses differently.
LLCs, like partnerships and sole proprietorships, are pass-through entities. Pass-through is a fancy way of saying that the company’s profits and losses “pass-through” to the owners or shareholders. The owners pay their share of the company’s profits on their personal tax returns.
While S-corps have pass-through taxation, C-corps lack this benefit and risk being taxed twice (double taxation) on corporate earnings.
A corporation pays income taxes on its profits or losses instead of its owners. It may pay part of its earnings to the owners in dividends, but this isn’t direct. In this case, corporations may keep some earnings.
Formation is another key difference between LLCs and corporations. Aspiring business owners must follow specific requirements when starting these businesses.
LLCs can be formed as single-member or multiple-member companies. LLC members file the company’s Articles of Organization with their state, then create an operating agreement to use when managing day-to-day operations. They also decide on each member’s percentage share of ownership, roles, and responsibilities.
While operating agreements aren’t required for LLCs, they’re strongly recommended to increase personal liability protection, set clear rules for all members, and prevent default regulations from governing the company.
A corporation is formed (or incorporated) by filing corporate organization documents called Articles of Incorporation in its home state. Additionally, the corporation must create a board of directors to oversee the business.
After a corporation’s Articles of Incorporation are filed, its board of directors must set bylaws that dictate daily operations, similar to an operating agreement.
Incorporating offers many advantages to business owners, including:
In our litigious society, incorporating to protect yourself just makes sense. No other structure gives you and your business the liability protection incorporation offers. When you incorporate, your personal assets aren’t 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.
Incorporation also comes with numerous tax benefits. Corporations must pay corporate tax, but some companies may have a lower profit tax than personal income tax.
Furthermore, corporations are legally entitled to many tax deductions not afforded to individuals. Their owners can even save thousands of dollars on self-employment tax yearly.
If your business has a “Corp.” or “Inc.” in its name, customers will consider it a more professional organization. These abbreviations also indicate that your venture has undergone formal procedures and follows state regulations, increasing its credibility.
Since corporations are separate from their owners, they can operate despite the owners retiring, passing away, or leaving. Corporations can also sign and fulfill contracts, acquire assets, and settle liabilities independently.
Several factors are crucial in choosing the best business structure for your new venture. Here’s a closer look at these considerations.
LLCs and corporations offer limited liability protection. However, this protection works differently in both structures.
If you incorporate, it’s important to remember that shareholders only manage certain parts of the business. They can appoint the board of directors, remove directors under justifiable conditions, and vote on basic transactions controlling their economic and ownership rights.
Generally, a corporation’s directors handle organizational strategy, establish company policy, and hire officers who manage daily operations. But in a statutory close corporation, members can control business activities themselves. Some LLCs operate with this level of management, as well.
Corporations can raise capital by selling their shares of stock, attracting potential investors. Additionally, they can easily offer stock options to employees after these benefits and acquire funding from banks.
Financing for limited liability companies can be obtained through business loans and grants. Individuals can also invest in these ventures, but they must become members to do so. From there, LLC investors may seek management rights.
Another factor affecting LLC funding is banks and venture capitalists being reluctant to finance an LLC. As a result, you could repay debts yourself, which reduces limited liability protection.
Finally, you must consider taxation when choosing between an LLC and a corporation. Each entity offers different tax benefits and creates potential disadvantages after formation.
Choosing the best entity for your business can be challenging, especially when the differences could spell success or disaster.
Doing your research ahead of time can help you make an educated decision. However, it’s also important to seek expert advice to steer your business toward the right path to success. Inc Authority has business formation experts who can explain these important differences to you 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 exist separately from their owners.
Other advantages of an LLC include the following:
The disadvantages of forming an LLC include the following:
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