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LLC vs Inc: Which Is Better?

LLC vs Inc: Which Is Better?

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Introduction

Whether you choose to set up your business as a limited liability company (LLC) or corporation (Inc), formal registration can be an onerous task.

Before deciding on your business setup, it is important to consider which type of business entity will best suit the needs of your organization.

Your chosen business structure will determine the legal formalities you must comply with.

A business cannot be both an LLC and a corporation. However, it is possible to change the designation of your business by completing the appropriate government paperwork.

You might choose to do this if your business is undergoing growth or significant change.

In this article, you can find out about the key differences between LLCs and corporations. Armed with this knowledge, you can make an informed decision about which business setup option will work best for your company.

What Is an LLC?

An LLC is a privately held company, owned by its members. It combines the features of a partnership firm and corporation, including flow-through income taxation and limited liability.

Compared to a corporation, running a business as an LLC tends to offer more flexibility.

Setup

LLCs are set up under the jurisdiction of state law. The process for setting up an LLC slightly differs depending on which state you are filing the application in.

You will usually be expected to file articles of organization with the Secretary of State, although some states will allow you to complete the registration documents online.

In some states, you will be expected to file a public notice; this is usually published in local state newspapers.

Working under the jurisdiction of state law can be complex, particularly for LLCs running operations in more than one state.

Differences in rules and regulations between states can generate extra paperwork and lead to inconsistent decisions or processes across the different sites.

Membership

An LLC can have an unlimited number of members or owners.

The members of an LLC do not own shares. Instead, they own a percentage of the company, which is often referred to as ‘membership interest’.

Trading is private, which means that shares of an LLC cannot be sold to the public. As such, an LLC cannot raise funds from the market through shares.

Transferring membership within an LLC can be more complex than transferring shares within a corporation.

Operating Agreement

It is important for LLCs to set up an operating agreement to outline:

  • The roles, rights and responsibilities of each member
  • How membership interest can be transferred between members. In some states, the LLC will be dissolved if an LLC member leaves and the operating agreement does not set out an acceptable process for the transfer of membership interest. It is important to establish a process to follow in the event of a member buyout or the death of a member.
  • Arrangements for the allocation of profits and losses

While setting up an operating agreement is not compulsory, if an LLC does not have one, it will be governed according to the default rules set out within state statutes.

Management

An LLC can either be managed by the members or a team of managers. Within a member-managed LLC, the owners are usually involved in the day-to-day running of the business.

In a manager-managed LLC, the members do not tend to have an active role in business operations.

Tax

LLCs are not considered to be separate vehicles for tax purposes by the Internal Revenue Service (IRS). This means that they offer better flexibility in terms of taxation.

Members can decide whether they want the business to be considered as a sole proprietor, partnership or corporation for tax purposes.

LLC profits and losses must be reported by the owners of the business via their annual tax return. The owners’ personal property is protected from business obligations and debts.

A single-member LLC will be taxed as a sole proprietorship, whilst a multi-member LLC will be taxed as a partnership.

This means that LLC members must report and pay tax on business income via their personal tax returns.

Unlike corporate shareholders, LLC members may also be required to pay self-employment taxes to cover Social Security and Medicare.

The legal requirements for an LLC are minimal. It is not necessary to hold meetings, keep minutes or log resolutions put in place by the company.

Annual General Meetings (AGMs) are optional and an annual report is not required by law.

LLC vs Inc: Which is Better for Your Business?
LLC vs Inc: Which is Better for Your Business?

What Is an Inc Business?

‘Inc.’ is an abbreviation of the word ‘incorporated’. It is used as a suffix, following the name of a business corporation. When compared with an LLC, a corporation is less flexible in some areas.

Many different organizations choose to run as a corporation, including for-profit, not-for-profit, public and private companies.

Setup

To form a corporation, you must submit a certificate or articles of incorporation. This will include information such as:

  • Company objective
  • Location
  • Stock information

The corporation name is divided into three sections:

  • Distinctive element
  • Descriptive element
  • Legal ending

Shares

The owners of a corporation are referred to as 'shareholders'.

Shares can be easily transferred between owners, so a corporation is a good option if you want to encourage external investment or sell public stocks.

The corporation refers to an artificial individual, or a separate legal entity that is independent of its members.

A corporation has its own rights and obligations, holds property in its own name and has limited liability.

When considering excess profits, corporations can offer better flexibility than LLCs. In an LLC, all income passes to its members, whereas an S Corp can pass income and losses on to its shareholders.

Tax

In the US, a corporation can be classified as either an S Corp or a C Corp for taxation purposes.

By default, all corporations are taxed as C Corps. This means that they must pay federal income tax on any corporate profits, after which the shareholders must also pay tax on dividends.

However, a corporation with 100 or fewer shareholders may be able to avoid double taxation by electing to be taxed as an S Corp.

An S Corp is not required to pay corporate income tax; however the company profits must pass through the shareholders’ tax returns.

Every shareholder will be required to pay tax on their share of the overall profits. In some cases, shareholders may be eligible to receive tax-free dividends.

Management

Management of a corporation tends to be rigid, with standard operating procedures in place. A board of directors will be elected to set out policies and oversee business operations.

The day to day activities of the business are managed by officers.

Within a small corporation, one person might be responsible for several different roles, including shareholder, officer and director.

In a larger corporation, shareholders are unlikely to be involved in the day-to-day running of the business.

Corporations must set bylaws to outline the rights and responsibilities of all parties, from officers to directors.

Corporations are legally required to hold an AGM, giving adequate written notice of the meeting date to all shareholders. Corporations must also compile an annual report. In many states, filing this report will incur a fee.

LLC vs Inc: How to Decide Which to Pursue?

The key differences between an LLC and a corporation relate to ownership, management, taxation, record-keeping and reporting.

Whether you choose to set up an LLC or a corporation, you will need to file official documentation with the state.

Both types of business entities will protect you from liability for business obligations.

  • Cost and ease of setup – Setting up an LLC tends to be more straightforward and cheaper when compared with incorporating.
  • Legal formalities – In general, a corporation is expected to comply with more regulations and requirements than an LLC. Corporations have to work in line with clear legal formalities and record-keeping requirements. For LLCs, legal formalities and record-keeping are less structured.
  • Tax – As an LLC, your business will benefit from pass-through taxation. This means that the LLC's income is taxable through its owners after it has been distributed. Corporations are double taxed, first at corporate level, then at individual level after the profit has been distributed to shareholders as dividends.
  • Corporate reporting – This is simpler for an LLC as no annual report is required; therefore, it is not necessary to create a balance sheet.
  • Company dissolution — If you want to dissolve your LLC company for any reason, there are fewer obstacles to overcome if you want to make changes to the business model.
  • Small businesses – If you have a small business or startup, an LLC may be the best option. This is especially true if you expect small profits or incur a loss. If the business does incur a loss, these can be recorded on the owner’s personal tax return to reduce their tax burden whilst they invest in the business.
  • Medium businesses – Medium-sized businesses are best suited to running as an S Corp, whereas larger businesses are best suited to running as a C Corp.
  • Large businesses – If you have a larger business and you want to benefit from movable shares, a corporation offers better prospects for profitability and growth. If you plan to grow your small business or you want to make shares available to the public, a corporation might also be the better choice.
  • Investment in the business – If you are looking for investment into your business, running it as a C Corp is often the best choice.
  • Number of members – There is no maximum number of members allowed in an LLC. However, an S Corp can only have up to 100 members.

Final Thoughts

When deciding on a structure for your business, it is important to know your business. Choosing wisely will mean that your company can continue to thrive.

Your decision should be based on the purpose of your business and the associated tax consequences of running it.

Regardless of whether you choose to set up as an LLC or corporation, your personal assets will be protected from creditors.

For the majority of new business owners, it is best to set up as an LLC in the first instance.

Fast-growing startups and companies seeking investment are better suited to incorporation as an S Corp or C Corp company.


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