It is important to know what LLC vs. Inc means and which one you should use for your business.
LLCs are limited liability companies that can be used by any type of company in the United States. LLCs offer the same protections as corporations but do not provide shareholders with additional tax benefits like stock dividends or capital gains.
On the other hand, an INC (corporation) offers more protection than LLCs because it has a greater separation between personal assets and corporate liabilities.
This article will break down these two structures and help you decide which business structure is best for your particular needs.
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 LLC, 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. 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 (the pass-through taxation).
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. An LLC gives members the ability to choose how they want it taxed.
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:
S corporation pays no corporate taxes; instead, income "passes through" the 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. 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 a number of 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 case of a corporation) and articles of organization (in 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.
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.
On the other hand, LLC members generally have no management responsibilities. Their duty is to perform services as requested by LLC management within certain financial limitations set forth in the operating agreement.
They cannot bind their company or others involved with it to any contract without prior approval of all partners (unless there is an operating agreement that allows otherwise).
While an LLC's management structure may seem less complex than that of a corporation at first glance (it's either member-managed LLC or a manager-managed LLC), choosing between these two entities should not necessarily depend on this factor alone because both models have their perks, depending on the business needs.
Corporations may attract investors who simply want to stay on the side and don't want the hassle, while LLC may seem more appealing for those business owners who want to be directly involved in running the business.
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.
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.
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. 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, you need to consider a few other things too.
Taxes for LLCs
The Internal Revenue Service treats LLCs as a pass-through tax entity 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, 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.
If you opt for an LLC tax without any further taxation election, your LLC doesn't have to pay federal income tax. LLCs' federal income taxes are at the tax rates for individuals, meaning that tax rates are figured out on a per-person basis. The tax rate is based on how much money you make in one year relative to your personal exemption.
LLCs are automatically treated as pass-through entities, and unless they choose to be taxed differently, the IRS files them under Subchapter K of the Internal Revenue Code. However, LLCs can choose whether they want to be taxed like corporations by filing IRS Form 8832 (from the IRS website).
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." 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.
We can split corporations into two categories according to income tax purposes. C corporation is taxed under Subchapter C, and S corporation is taxed under Subchapter S. Unlike an S corp, C corps are subject to double taxation.
Subchapter C is the default tax code for corporations. Your corporation is a separate taxable entity that reports its income and expenses on the corporate level, not on an individual basis. As a result, businesses are taxed at the corporate rate.
However, you can choose to be taxed as an S corp instead. When you do this, your business is not taxed as a separate entity at the corporate level. Instead, it simply passes its corporate profits or losses on to you personally, and taxes are levied on this personal income instead of corporate income tax rates.
LLCs can opt for S corp taxation regardless of their type, but corporations must meet certain requirements. To check the full list of requirements for S corporations, contact the IRS.
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.
Who Pays More Taxes, LLC or S Corp?
It depends on the taxation election. Because corporate and shareholder levels are taxed separately, C corporations and their shareholders generally pay more taxes than S corporations or LLCs.
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.
Is a single-member LLC an S corp or C corp?
A single-member LLC is always treated as a sole proprietorship unless it chooses to be taxed as a corporation (both S or C).
Does a Corporation Need to Hold Annual Meetings?
Yes, one annual meeting is the required minimum for every corporation.
Do Corporations and Llcs File Annual Reports?
Most states require an annual report from LLCs and corporations alike. Annual reports are filed online or by mail with the corresponding Secretary of State.
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.
The Final Verdict: LLC vs. INC.?
It is important to understand the differences and similarities between an LLC and a corporation.
An LLC can be easier for small business owners because it doesn't come with some burdensome reporting requirements that corporations do, such as filing annual reports, holding directors' meetings, or having bylaws.
That being said, it's important to know your business strategy before deciding on which type of entity you want to form.
If you're unsure how these entities differ or what they mean for your company, talk with a lawyer or accountant who can offer legal or financial advice specific to your situation.