Incorporating vs LLC: The Similarities and Differences That You Need to Know

12

Min Read

David Maina

There are two main types of business entities in the United States: LLCs and corporations. Both have their own unique benefits and drawbacks, so it can be difficult to decide which is the best option for your business. It is common for a sole proprietor to change to an LLC or corporation as their business grows.

In this blog post, we will discuss the similarities and differences between LLCs and corporations, so that you can make an informed decision about which type of company is right for you.

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What exactly is incorporation?

Incorporation is a legal process that creates an entity separate from its owners or shareholders. Many business owners start off as a sole proprietor and then incorporate. This legal entity can be used to conduct business activities without the owner/shareholder is personally liable for those activities. The two most common types of corporations are S-Corporations (S Corp) and C-Corporations (C Corp).

What are the differences between S- and C-Corporations?

The main difference between S- and C-Corps is taxation. S Corps are pass-through entities, which means that the corporate profits and losses of the company are passed through to the shareholders and taxed on their individual tax returns.  

C Corps are subject to the imposition of taxes on the same income, assets or financial business transactions at two different points of time, meaning that the profits of the company are taxed at the corporate level and then again when they are distributed to shareholders.

What Is A Limited Liability Company (LLC)?

A limited liability company or LLC are very similar to corporations, but they have a few key differences. Like S Corps, LLCs are pass-through entities, meaning that the profits and losses of the company will be passed through to the members and taxed on their individual returns. This is one of the main reasons why many businesses choose LLC status over other business entities. Read more about when you should start an LLC.

LLC Vs Corporation: Limited Liability Protection

A similarity between LLCs and corporations is that they both offer limited liability protection to their members. This means that their LLC owners cannot be held personally liable for the debts, business obligations, or wrongdoing of their business.

If you have an LLC or corporation, creditors can only go after the company's assets to satisfy their claims – they cannot come after you personally unless they pierce the corporate veil (which is rare).

The corporate veil -- also known as the corporate veil -- is a concept used to describe the separation of a company from its owners for liability reasons. A corporation or limited liability company (LLC) is established as a "shield" or separate legal entity for the people who own it (limited personal liability) for the various debts of the business.

In general, if a corporation or LLC is considered to be completely independent of its investors and operators, those owners and managers cannot be held responsible for the company's activities. The company and its people are two distinct entities. This also means it is a separate taxable entity.

LLC Vs Corporation: Management and Business Structure

Corporations and LLCs have a different management structure. Corporations must be run by a board of directors, who are elected annually by shareholders at an annual meeting. The board chooses officers (such as the president) to run day-to-day operations for the corporation; these officers can also be shareholders but do not have to be.

LLCs are less formal and can be run by their members (owners) or by managers who are hired to run the company but don't have any ownership interest in it. With a manager managed LLC, there is no requirement that an LLC hold annual meetings, although they may choose to do so if they would like to keep shareholders informed about what's going on with the company.

Ownership

One of the biggest differences between LLCs and corporations is how they are owned. A corporation has shares of stock that can be bought, sold, or transferred to other people; these shares represent an ownership interest in the company.

LLCs do not have stocks or shareholders; instead, their owners are called "members." The members of an LLC can be individuals, other companies, or even trusts. Members might have different percentages of ownership interest in the company than each other; for example, one member may own 30% while another owns 65%.

LLCs do not have to issue membership certificates like corporations do with stock certificates, but they may choose to keep track of their membership interests by issuing these certificates or keeping them on file internally.

In addition, all members of an LLC have an equal vote on major decisions, regardless of how much money they have invested in the company. This is not the case for corporations, where shareholders who own more shares get more votes.

LLC Vs Corporation: Formation

Both corporations and limited liability companies can have one owner (called a single-member LLC) or multiple owners (a multi-member LLC) for LLCs. Both types of entities must file articles of incorporation or organization with the state in order to form.

The main difference between LLCs and corporations is that LLCs do not have to hold a shareholders' meeting or vote on major decisions, like electing directors. This makes the formation process for LLCs much simpler than for corporations.

However, both entities must follow the same basic rules when it comes to forming a company. For example, both entities must include the name of their owners in the formation documents.

Also, your business name may be rejected by your state if it is too similar to another company's name that already exists or you do not include certain words like "Corporation," "Limited" or LLC.

Your business name must also be unique. You cannot use a name that has already been used by another company in your state, and you cannot use a trademarked name unless you have permission from the owner of that trademark to use it as your business's legal name.

Another similarity? When registering with their state, both entities must designate a registered agent for service of process. A registered agent is an individual or company responsible for receiving legal documents on behalf of the business, such as summonses or subpoenas.

LLC Vs Corporation: Double Taxation?

When a corporation is taxed depends on how it has elected to be classified for tax purposes: as a C Corporation, S Corporation, or an LLC.

C Corporations (C-corp) are taxed at the corporate level on their profits, meaning the shareholders do not pay corporate taxes on their share of the income. This is called "double taxation."

S Corporations pass through their income and losses to their shareholders, who report it on their individual tax returns. S corporations are not subject to this taxation because the shareholders pay taxes on the corporation's income. In fact, S corporations are also known as "pass-through" entities because they pass through their income and losses to the shareholders.

LLCs can be taxed as either a C Corporation or an S Corporation, depending on how many members it has (one member LLCs are treated like sole proprietorships, and two or more member LLCs are treated like partnerships). Company profits pass through to the members, who pay income and self-employment taxes on their proportion (use our free tax calculator to determine how much you pay in self-employment taxes)

However, an LLC can choose to be taxed as a corporation by filing Form 8832 with the IRS. If this is done, then the LLC will be subject to double taxation like a regular corporation.

So, what's the best option for your business? That depends on your specific situation. If you're looking for limited liability protection and don't mind paying taxes on the company's income twice, then a corporation is a good option. But if you want to avoid double taxation, an LLC is a better choice. Weigh the pros and cons of each entity type before making a decision.

LLC Vs Corporations: Reporting and Record Keeping

Corporations and LLCs are both required to keep records of their members (or shareholders) and financial information. They also must file annual reports with the state for their legal business entity status to remain active.

However, corporations have a few more requirements than LLCs when it comes to record keeping; they have stricter reporting requirements as well. For example, corporations must keep records of who owns their shares and how many, as well as minutes from all board meetings.

LLCs do not have to keep any of this information on file; however, it's often a good idea for them to do so. Corporations that fail to follow these rules risk losing their limited liability protection (which means shareholders could be liable for company debts personally); LLCs do not run the same risk because they don't need to adhere as strictly to these rules.

LLC Vs Corporation: Classes and Transferability of Interests

LLCs and corporations have different approaches to ownership interests. A corporation may issue shares of stock in multiple classes with different rights attached, such as voting or dividend preferences; however, an LLC cannot do this. All members must receive the same set of rights when they join an LLC.

LLCs also don't allow new business owners to acquire an ownership interest in the company without the consent of all other members. This is different from a corporation, where any shareholder can buy or sell shares to whoever they want (as long as it's not insider trading).

This difference between LLCs and corporations comes into play when someone wants to sell their business. If the buyer wants to acquire an ownership interest in the company, they would have to go through the existing members of the LLC. If the buyer wants to acquire shares of a corporation, they can simply purchase them from any shareholder who is willing to sell.

LLC Vs Corporation: Funding

One of the big benefits of incorporating your business is that you can raise money by selling shares of stock to investors. This is not possible with an LLC; while members may contribute money to the company, they cannot sell their ownership interest in it.

Another time this difference is important is when a company wants to go public. A corporation can IPO (initial public offering), which means it sells shares of stock to the general public and becomes a publicly-traded company. LLCs cannot do this; they must remain private companies with a limited number of members.

LLC vs Corporation: Post-formation Compliance

The differences between LLCs and corporations don't end once they are formed. Each type of business structure has ongoing requirements that must be met in order for the company to remain active and compliant with state laws (and receive federal tax benefits).

Such requirements include:

  • Filing yearly reports
  • Appointing a registered agent
  • Paying franchise taxes

Both LLCs and corporations can be dissolved if they do not meet these requirements, allowing creditors to go after business owners for unpaid debts. However, some states allow businesses that are in good standing with the state but not compliant with certain tax or reporting duties to apply for reinstatement.

LLC Advantages and Disadvantages

LLCs have perks over sole proprietors and other types of business entities, like corporations or partnerships, but also LLC disadvantages that you should be aware of before starting your limited liability company.

Advantages

Here's a quick snapshot of the advantages of an LLC.

  • Owners can't be held personally liable for business debts (with some exceptions for legal liability)
  • LLCs are less complex than corporations and do not have many of the formalities required by state law (such as shareholder votes)
  • Setting up an LLC is usually less complicated than starting a corporation, as it only requires minimal documentation
  • LLCs offer more flexibility when it comes to management -- members have the option of running the firm themselves or delegating management to others
  • Tax advantages (pass through tax entity-- flow through taxation-- to avoid being taxed twice)

Disadvantages

  • Membership in an LLC is exclusive - new members can only join with the consent of all other members
  • An LLC cannot issue shares of stock in multiple classes like a corporation can. This means that all members have the same rights and responsibilities, which can be a disadvantage if one member wants to sell their ownership interest
  • LLCs are not able to go public like corporations can
  • The state may require an LLC's operating agreement to be written - this is not required for corporations. An operating agreement is a contract made between the LLC membership interests that states the operation, management structure, membership, and distribution of income. Depending on the operating agreement, an LLC can be more difficult to transfer ownership stake.

That said, if you're looking for the flexibility of a partnership with some of the legal protections afforded to corporations, an LLC may be the right business entity for you.

In addition to being simple to set up and maintain, an LLC can give you peace of mind knowing that your personal assets are protected if something happens with your company's finances.

Corporations Advantages And Disadvantages

Here are a few of the drawbacks and benefits of setting up a corporation:

Advantages

  • Corporations can raise large amounts of money by issuing shares of stock
  • Corporations are more attractive to outside investors compared to other types of business entities because they have limited liability and their ownership is easily transferable
  • They have perpetual lifetimes -- a corporation can exist beyond the deaths of its owners.

Disadvantages

  • Corporations are complex business entities that have many formalities and requirements (such as holding annual shareholder meetings)
  • A C corporation has to pay corporate income tax on their profits, and when their shareholders receive their dividends, they also have to pay federal income tax on what they have earned, as dividends are considered income.
  • Corporate tax filing requirements are more complex. States demand the filing of Articles of Incorporation, corporate by laws, and annual reports from corporations.

LLCs Versus Corporations: Choosing what's best for you

It's important to choose the right business entity for your company because each one comes with different benefits and drawbacks. LLCs offer limited liability protection, but may not be as attractive to investors due to their restrictions on classes of ownership or membership interest or transferability right.

Corporations have more flexibility when it comes to raising capital and issuing shares in different classes, but they also have more stringent reporting requirements and annual fees.

Ultimately, it's up to you to decide what type of business entity is the best fit for your company. This is not legal or financial advice. Please consult with a law firm or lawyer for legal counseling.

David Maina
David is an experienced B2B financial copywriter, specializing in content related to accounting, financial planning, and small businesses. Over the years, he has helped fintech brands win more traffic and skyrocket conversions with engaging, long-form content. A nerdy interest in numbers, and passion for creative writing drives him to create financial content that's truly unique. You can reach him at financeandinsurancewriter.com

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