LLC vs Incorporation | What’s the Difference?
It is important to know what LLC vs. Inc means and which one you should use for your business.
As a seasoned expert in business formation, together with my team of business experts, we've guided countless entrepreneurs through the maze of legal structures, helping them understand the nuances of LLCs and Corporations.
This article will break down these two structures and help you decide which business structure is best for your particular needs.
Quick Summary
- LLCs offer flexible tax options and limited liability, while corporations are structured for larger investments and subject to more regulations.
- LLCs can be single-member or multi-member, and corporations can be C corporations, S corporations, or non-profit companies, each with distinct tax implications and operational structures.
- According to the Small Business Administration, as of 2021, LLCs represent about 35% of all small businesses in the United States, illustrating their widespread adoption for liability and tax advantages.
- I always tell my clients that choosing between an LLC and a corporation depends on the business's specific needs, including tax preferences, investment requirements, and desired operational flexibility.
What Is LLC vs. INC.?
LLC is short for a limited liability company, while Inc. stands for incorporated.
LLCs and corporations are both business structures that have a separate legal identity from the owners or shareholders of the company, which means they do not face personal liability for any debts the LLC or corporation may incur.
Both business structures have sub-categories within them.
LLCs can be single-member or multi-member LLCs, or they can even extend to become a limited partnership or a limited liability partnership. Incorporations are either C corporations, S corporations, and non-profit companies.
Types of LLCs
LLCs are pass-through entities that pass their income and loss to the owners' personal tax returns.
Drawing from our experience, this means that an LLC does not pay any taxes on its profits; instead, all of the company's earnings pass through to each member's individual tax return, where they are taxed at a personal rate (pass-through taxation).
A limited liability partnership (LLP) represents the partnership interests of the LLP members. An LLP resembles a general partnership, except that partners are not personally liable for business debts (similar to a traditional LLC).
A limited partnership (LP) is an agreement between two or more parties to engage in a business venture and divide any profits. There are also some key differences:
- LPs require at least one general partner who is liable for the partnership debts.
- While LLCs do not pay tax on their income, an LP will incur taxes on its income (similar to a traditional corporation).
A limited liability company (LLC) is more flexible than other business structures. It combines the pass-through taxation of a sole proprietorship or partnership with the limited liability features of a corporation.
LLC gives members the ability to choose how they want it taxed.
Related Article: Who Is Liable in an LLC
Types of Corporations
A corporation represents a separate legal entity owned by shareholders.
Corporations are good for large projects that require investment and the ability to raise capital, but they also come with many more rules and regulations than LLCs do.
An S corporation is an incorporated business structure in which taxation passes through to its shareholders rather than being levied on it as a corporate tax.
Our clients who own S corporations pay no corporate taxes; instead, income "passes through" their S corporation to each shareholder's personal income tax return (as dividends or even self-employment). S corps don't have to face double taxation as C corps do.
The S taxation election allows a business owner of a pass-through entity to choose to be taxed as a corporation and not at their individual income tax rates.
One of the benefits of doing so is that S corp avoids double taxation on earnings, avoiding both corporate-level taxes and shareholder-level taxes (as in dividends or capital gains).
A C corporation represents the traditional corporate model with a board of directors, officers, and shareholders.
From our first-hand experience, these companies are required to file formal federal documents, such as articles of incorporation, corporate bylaws (which govern the internal corporate structure), and minutes from shareholder meetings.
Formation Process: LLC vs. Corporation
The process of forming an LLC and a corporation is rather similar. In both cases, you must take several preliminary steps to make sure the business entity is set up correctly.
Both LLCs and corporations will typically begin by drafting articles of incorporation (in the case of a corporation) and articles of organization (in the case of LLCs) that outline information such as how much capitalization has been raised for the company, what kind of business it's going into, management structure, etc.
Generally, articles of incorporation are more detailed and contain a greater number of provisions.
In both cases, you have to file these documents with the Secretary of State.
The filing fees for the registration differ from state to state.
Business Operations: LLC vs. Corporation
The day-to-day operations of LLCs are specified in an LLC's operating agreement.
On the other hand, corporations are run according to state laws and bylaws of their boards by the terms specified in the incorporation articles.
Through our practical knowledge, the management structure of a corporation is more complex than that of an LLC as it involves at least three persons: president, secretary, and treasurer.
In the case of a small business with only two shareholders or partners, one person can hold both positions if he/she has been authorized to do so in written form (partnership agreement).
In addition, corporate officers have duties determined by the law and can be held accountable for management missteps.
Related Article: LLC vs Ltd: Key Differences
LLC members typically lack management duties, focusing instead on tasks within agreed financial limits.
They can't commit the LLC to contracts without all partners' consent unless allowed by the operating agreement.
Despite seeming simpler, we always advise our clients not to hinge solely on complexity when choosing between a member-managed or manager-managed LLC as both structures offer unique benefits tailored to different business requirements.
Corporations appeal to passive investors, whereas LLCs attract owners desiring active involvement in their business operations.
Ownership Interest: LLC vs. Corporation
Corporations and LLCs are both entities that separate your personal assets from business ones.
Ownership interests are the amount of interest you own in either a corporate entity or how much money each shareholder would get if a corporation was dissolved and all its assets liquidated to pay off any debts first.
Any remaining profits would be distributed amongst shareholders based on ownership percentages.
From our experience, the difference between corporate ownership interests and LLCs is what happens when something goes wrong with the business.
Suppose an individual who owns part of a company wants out for whatever reason.
In that case, they can sell their shares back to other owners at market value, which allows them to leave without worrying about losing any past investments into it.
An investor's exit strategy has no impact on corporate earnings—all corporate net income stays within the company.
LLCs, on the other hand, do not have corporate stock.
The owner of an LLC is called a "member." Since there's no corporate stock, the only way to become a member is for someone else who already owns membership interests in the company to invite you as part of their share ownership group.
However, in most cases, a new member must have consent from all the other members to join an LLC.
"Both LLCs and corporations offer personal liability protection for their owners, yet an LLC is owned by one or more individuals, whereas a corporation is owned by its shareholders."
- Jon Morgan, CEO, Co-Founder & Editor-in-Chief of Venture Smarter
Tax Deductions: LLC vs. Corporation
A limited liability company (LLC) is a form of business organization in which owners enjoy limited liability protection and financial responsibility for their businesses [1]. According to the Small Business Administration, as of 2021, LLCs represent about 35% of all small businesses in the United States, illustrating their widespread adoption for liability and tax advantages.
In terms of taxation, LLCs & corporations have the same rights as any other individual or corporation—they can take all normal tax deductions related to running their businesses.
However, we always advise our clients to consider a few other things too.
Taxes for LLCs
The Internal Revenue Service treats LLCs as pass-through tax entities for tax purposes.
The business itself does not pay taxes on money it earns, and the LLC's members do not report any of the business income from their shares in an LLC as individual tax returns—it is only reported on personal tax returns.
However, based on our experience, if you are a member of an LLC, you must pay tax on your share of profits from the business. Self-employment taxes can also apply to members of an LLC. Self-employment tax is a social security tax designed to fund the Social Security system.
Choosing an LLC structure without additional tax elections means the LLC itself isn't subject to federal income tax.
Instead, profits are taxed at individual rates for each member, based on their personal income.
LLCs naturally benefit from pass-through taxation, classified under Subchapter K, unless they opt for corporate taxation by submitting IRS Form 8832 [2]. According to IRS data, less than 5% of LLCs choose to be taxed as corporations, highlighting the preference for pass-through taxation benefits.
Taxes for Corporations
The tax treatment for corporations is similar to that of LLCs in many ways: corporate income and expenses are reported directly by the corporation itself and taxed accordingly at different rates depending on how much profit it makes every year.
However, there are a couple of key differences.
Corporations are taxed at different rates depending on their size and earnings every year.
The IRS charges them what is known as "corporate income tax." Drawing from our first-hand experience, a corporation can also incur certain other taxes like excise or franchise tax if they reach certain thresholds or engage in specific activities.
The tax rate for small corporations and companies varies depending on the state where it's based – some states charge no corporate tax at all.
Corporations are categorized for tax purposes as C corporations, taxed under Subchapter C and subject to double taxation, or S corporations, taxed under Subchapter S, avoiding double taxation by passing profits or losses directly to the owners' personal income.
C corporation is the default status, where the business is taxed at the corporate level. However, businesses can elect to be taxed as an S corp, allowing profits to be taxed only at the individual level.
LLCs can also choose S corp taxation, but specific IRS requirements must be met for corporations to qualify as S corps.
FAQs
Can a Company Be Both an LLC and a Corporation?
No, LLCs can't be corporations simultaneously, but LLCs can choose to be taxed as a corporation and use some tax advantages.
Does a Corporation Have to Have a Registered Agent?
Yes, corporations and LLCs need to have a registered agent or hire a registered agent service if they want to set up a legal business entity in any state.
Does a Corporation Need to Hold Annual Meetings?
Yes, one annual meeting is the required minimum for every corporation.
Can a Corporation Be a Sole Proprietorship?
Yes, a sole proprietor can be the only member of a corporation but must also perform the role of its president and a sole shareholder.
References:
- https://www.mass.gov/info-details/limited-liability-companies-and-limited-liability-partnerships
- https://www.irs.gov/pub/irs-pdf/f8832.pdf
