Understanding the key difference between an LLC and a C corporation is a vital step in forming your new business. You should not proceed until you have a good understanding of these organizations to make an informed decision about the business structure your new company should adopt.

What Is Incorporation?

Incorporating your business means you're ready to take steps to officially register your company with the state in which you operate. Incorporating means you're growing from a sole proprietorship or general partnership to a more established business model. That means your company will become a legal business entity that is completely separate from you and any other founding members. When you incorporate your business, you will typically choose one of two structures:

  • A limited liability company, or LLC
  • A corporation

Legal Implications of Incorporating

With an LLC business structure, owners are able to easily transfer their ownership to another individual. Your specific state might impose certain requirements, but incorporating is generally a simple process. Unless your state has regulations that say otherwise, it is usually possible to convert from one business structure to another. For example, if you originally incorporate as an LLC and later decide it's necessary to convert to a C corporation, you'll be able to do so in most cases. It's also usually possible to transfer your incorporation from one state to another, should it become necessary.

When you incorporate your business, the company will usually be taxed at a lower rate than individuals and sole proprietorships. Additionally, a corporation can own shares in another business, and the dividends they receive from those shares can be partially tax-free.

Both an LLC and a corporation have the ability to continue operating even after the founding owners have passed away. This allows the business to carry on in the event of an owner's death, providing financial and job security for stakeholders and employees. An LLC can gain funding through membership interests, while a corporation can do so through stock sales and convertible debts. Finally, a corporation is issued its own credit rating, which is separate from the owner's personal credit score.

What Is a C Corporation?

A corporation is a business structure that is established as a separate legal entity from the company owners, providing a certain measure of protection for the assets of owners and stakeholders. This type of business structure also protects individual owners and stakeholders from claims a creditor might have against the business. When you incorporate your business, it is automatically classified as a C corporation, otherwise known as a "regular" corporation. C corporations pay taxes separately from owners and stakeholders. For example, expenses and income are taxed to the company, rather than its owners.

If, however, the company's profits are paid out to owners in the form of dividends, those owners are required to pay income tax on those dividends. This creates what is known as "double taxation," which means the profits are taxed to the corporation and then taxed again on a personal level when they are paid out to the owners as dividends. For this reason, many small business owners choose to avoid incorporating as C corporations.

A corporation is automatically classified by the state as a C corporation unless you specifically choose to incorporate as an S corporation when establishing your business with the state.

Corporation Characteristics

As you consider different types of corporate structures, it might be helpful to know that most business owners consider issues related to taxation to be one of the biggest differences between C corporations and S corporations. S corporations have what is known as a "pass-through" structure, similar to an LLC.

C corporations, however, are considered to be separate entities in legal terms, meaning the company is taxed separately from its owners. This also means C corporations can be subject to "double taxation" when profits are paid out to owners or shareholders as dividends. A C corporation is required to pay taxes on corporate profits, while owners are taxed again on an individual basis on any profits that are paid out as dividends, resulting in this double taxation.

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