There are many benefits to incorporating your small business. In this article, we will compare Incorporations (inc) and Limited Liability Corporations (LLC).
What is a Corporation (Inc.)
A corporation is a type of organization that offers limited liability to its investors. A corporation can be either a public or private company with shareholders who have the right to share in the company’s profits and assets. The shareholders receive shares of stock as evidence of ownership.
Types of corporations
There are three main types of corporations:
A “C” corporation.
A-C corporation is subject to C corporations regulations, which can be easy for small business owners to follow. The tax treatment of a C corporation closely follows that of a non-profit organization (PEO), with additional consideration given to the “pass-through” taxation provision for small businesses.
An “S Corporation.
An S corporation is best for small businesses with no more than 100 shareholders and new businesses. These companies are not taxed federally. Instead, they pay taxes directly to the government by filing IRS Form 1120S. The IRS taxes S corp at a flat tax rate of 15% instead of the progressive tax rate schedule applicable to other businesses.
An LTD (Limited Liability Company).
An LLC is a cross between a partnership and a corporation for taxation purposes. Like a corporation, an LLC has limited liability; Like a partnership, it has flow-through taxation. An S corporation’s shareholders are subject to double taxation; however, there is only one level of tax in an LLC.
What is an LLC?
An LLC (limited liability company) is a type of organization formed by at least one person, and it protects its owners from being personally liable for any debts incurred by the business.
The LLC has two forms:
If there is only one member, the LLC is called a “member-managed” LLC. A multi-member LLC can be either member-managed or manager-managed. In other words, an LLC can be member-managed by an individual owner or manager-managed by one or more owners.
A member-managed LLC must have at least two LLC members, and if it’s manager-managed, it may have any number of members.
The LLC is a type of business entity defined under Title 8 of the United States Code. LLC’s are classified as “socially disadvantaged” for federal tax purposes, and the Service grants them preferential tax treatment over corporations, partnerships, and sole proprietorships.
The IRS has determined that LLCs should be treated as partnerships for federal income tax purposes.
What do LLC and Inc have in common?
The most important thing they have in common is that both are based on the idea of a “limited liability.”
Both Inc and LLC owners /members are protected from all liabilities of their business. This means you cannot be held liable for any debts or obligations of your business.
It is also important to note that limiting liability for the business owner is not a right; it is a privilege granted to the owners by the state or organization.
When you incorporate your business, you lose this privilege. The corporation is a separate legal entity, and the owners are not protected from any liabilities that may incur.
Difference Between LLC and Inc.
The main features that differ between an LLC and inc are as follows:
- An Inc can have an unlimited number of shareholders. However, an LLC has a limit on the number of members. This limit varies from state to state but is usually either one or two. In some states, you can choose to have an LLC with no members at all.
- The shares of stock for LLCs are not transferable, which means that there is much more privacy concerning any business transactions.
- In an LLC, liability is limited to the owners only, while in an Inc, you can be liable for up to $500,000 per person and an unlimited number of people.
- A member of an LLC automatically has a vested interest in the business, and therefore his/her shares are not freely transferable. This also means that he cannot be held personally responsible for debts incurred by the LLC, such as taxes or other accounts (e.g., payroll), which is not the case with Inc owners.
- An LLC has fewer tax consequences than an Inc. This means that the owner is subject to income taxes on his share of profit (also known as passive income), but he does not have to pay taxes on any money he uses for personal living expenses. On the other hand, an Inc has more tax consequences. For example, if a shareholder carries out personal trading using the company’s funds, they may be taxed twice—once for their personal income and once for corporate profits.
LLC vs. Corporation Ownership
LLCs and corporations have distinct ownership rules. Corporations are owned by shareholders, while members of an LLC are effectively partners.
Depending on the type of corporation you choose, you may need to meet certain formalities in order to maintain its status as a corporation. For example, you may need to hold formal elections for board members and keep records of the annual meetings minutes.
Difference Between LLC and Inc. Management
LLCs are managed by members, while corporations are managed by directors and officers. In a corporation, shareholders elect a board of directors. Directors hire corporate officers who manage the day-to-day operations of the corporation.
LLCs don’t have separate classes of owners and managers. All members manage the LLC on a day-to-day basis, although you can appoint one member as your managing member to handle routine activities such as paying bills or filing bank deposits. LLCs are subject to state law rules on management.
LLC and Inc. Reporting and Recordkeeping
LLCs and corporations are subject to different reporting requirements. For example, you must file certain annual reports with the state. However, each corporation’s nature and size may result in different reporting requirements.
However, LLCs are required to keep track of members’ contributions on a report called a “membership interest ledger” (MIL). You can keep this ledger in a book or spreadsheet, but you must make sure that the members have access to it.
Structure Features of Corporations and LLCs
There are certain structural features of both incorporations and LLCs:
- Limited liability companies (LLCs) can be structured in a variety of ways to protect the personal assets of the owners. While not every state allows single-member LLCs, single-member LLCs can become very effective at protecting assets from creditor claims.
2. An LLC that is owned by one individual can have the same protections as a corporation. For example, an individual’s assets are protected because creditors of an LLC have only one place to look for payment—the business itself.
And, if the business is ever sold, the creditor of an LLC can only take the funds that were contributed to the LLC by the owners.
3. Additionally, in a single-member LLC, creditors have only one choice for how to collect their debt—compel transfer of assets from the owner.
4. In a corporation or partnership, creditors can go after an owner’s personal property to satisfy a debt. This gives creditors more power over personal property than if the owner owes money to a business.
Therefore, an LLC allows for the protection of the owner’s assets by making it much more difficult for creditors to access them. LLCs are structured with two types of members—members and managers.
The manager is usually an individual who is responsible for operating the company as a business and arranging its day-to-day operations. In most states, managers have limited liability, whereas members do not (with some exceptions).
- Inc. vs. LLC: Limited Liability Protection
For an LLC, liability protection is based in part on where the business is located and the number of owners. In most states, an LLC is treated as a separate legal entity from its members and managers.
Therefore, if the LLC (or one of its owners) causes harm to someone else, that person can sue the company for damages—but not necessarily any of the owners.
Generally speaking, a corporation is a separate legal entity and exists separately from its shareholders. This means that in most cases, the shareholders of a corporation are not liable for the company’s debts and other obligations. Instead, most states provide limited personal liability for corporate shareholders.
Some states also offer “piercing the corporate veil,” which allows certain creditors to sue shareholders or other owners of a corporation.
2. Inc. vs. LLC: Maintenance and Requirements
You will need to file a certain annual report with your state. You will be required to send tax returns, financial statements, and other reports for the previous year to your local government.
You will also be required to maintain the required LLC documentation for the duration of your organization, which could last a few years or even longer.
Your state can enforce certain requirements, such as maintaining certain records and submitting information to your state. You will also need to keep the required records together and in a specific location.
LLCs and corporations both have the same set of business rules. For example, if you own 80% of an LLC, you are considered to be its manager. In this case, LLC owners are legally responsible for the business debts and obligations of the LLC.
However, not all states follow this simple rule. Some states may allow LLC owners to be personally liable for their actions in the LLC.
LLC vs. Corporation: Taxes
You must pay taxes on the income and expenses of both an LLC and a corporation. However, you don’t have to pay the same taxes on each entity. Some LLCs are taxed as partnerships; others are taxed as corporations.
LLCs are not required to file corporate tax returns, but a few states require that they file corporate taxation returns.
These entities may file annual personal tax returns instead of the corporate tax return. In those states that require LLCs to file corporate taxes, LLC owners do pay federal income tax in most cases.
LLC Taxes are:
- Federal income tax on the business income earned by LLC
- Personal Income tax of each member (As a general rule, owners are only required to pay tax on business profits that they receive.)
- Interest and penalties may be applied if you don’t meet tax filing requirements.
- State sales taxes. In most states, LLCs do not have to pay sales tax separately from the owner’s income. Sales tax is often applied to the business’s profit.
- State corporate taxes. Some states have a franchise tax that is applied to each member of the LLC; others require that the LLC file a return to the state and pay an annual fee.
It is generally preferable to keep your business in one state or another because this way, you can benefit from the labor force, banking, and other industries within your same area. By choosing another state, you will be able to keep receiving these benefits without having to relocate your business.
Corporation Taxes are:
- Corporate Income Tax is a tax levied on the corporation’s profits. The tax rate decreases as the company make more money.
- The cost of incorporating can be high. The first fee is the application fee. If your company is denied, or you choose not to form a corporation, there will also be a $50-per-share filing fee. This amount can be reduced by making charitable contributions of at least $1,000 to other non-profit organizations.
LLC vs. Corporation: Legal Discrepancies
There are several types of legal formalities that you can implement in your business. LLCs require corporate status, as well as a written operating agreement, while corporations do not.
The advantage to incorporating as opposed to proceeding with an LLC is that your business will be able to file for federal tax exemption right away.
LLC vs. Corporation: Split-Share Agreement
An owner or member can modify a corporation’s bylaws in order to create special rules and policies that are adhered to for all shareholders/members. If you don’t want to create your own bylaws, you can instead use a split-share agreement.
With this, each shareholder/member has an equal share of the company. You delineate specific powers and authority for all shareholders/members and specify how profits are to be distributed.
LLC vs. Corporation: Duration
Both LLCs and corporations have indefinite terms-the company continues as long as it is successful or until it decides to dissolve itself.
The most common reason that companies dissolve themselves is when they either fail to generate adequate revenue, or their owners want to shut down business operations for another reason.
There are a few major differences between an LLC and a corporation. A corporation is a for-profit company that is registered to pay taxes as a separate entity.
You must keep paperwork and records in order to remain corporate compliant. Because of the legal business structure, corporations are easier to manage.
An LLC is a type of business entity that provides limited liability for its members/owners if the business fails or experiences financial loss. Although some states do allow LLCs to be taxed as partnerships, most have them register as corporations or sole proprietorships.
Which one to choose depends on your business needs and goals. Both entities have their own pros and cons. If you are just starting out, it might be best to choose the structure that best suits your startup needs.