Incorporate vs. LLC is a dilemma that some people face when they are choosing a legal structure for a new business. Basically, an incorporated business, or corporation, is a separate entity with its own rights and liabilities, while an LLC, or limited liability company, is a cross between a corporation and a partnership, offering the benefits of both. When choosing between the two, aspiring business owners should take their budgets, needs, and goals into consideration.

Understanding Corporation and LLC

Corporation and LLC are two of the most common types of business structure. When a business is incorporated, it transforms from a sole proprietorship or partnership into a business entity unto its own, distinct and separate from its founders or owners. An LLC, on the other hand, is an entity that provides its owners with protection against personal liability and some tax advantages.

A corporation and an LLC are similar in that they are both established through the filing of paperwork with the state government. In addition, they both ensure that their owners will not be personally liable if the company faces a lawsuit or financial trouble.

A corporation and an LLC are different in terms of management and tax structure. Their differences can be complex when the finer details of both entities are taken into consideration. It is recommended that aspiring business owners seek the assistance of a lawyer when they are trying to determine which of the two best suits their needs.

Pros and Cons of a Corporation

Pros

  • A corporation allows more flexible management of excess profits.
  • Ever since 2015, dividends are taxed at a lower rate than gross income. A corporation can structure dividends in a way that produces the best tax outcomes for its shareholders.
  • A corporation is able to issue shares easily, while an LLC cannot.

Cons

  • A corporation is subject to double taxation.
  • The formation of a corporation requires extensive paperwork.
  • A corporation must meet more requirements, including adopting bylaws, electing a board of directors, holding annual meetings, and creating formal financial statements.
  • A corporation generally has significantly greater record-keeping requirements than an LLC.

Pros and Cons of an LLC

Pros

  • An LLC ensures that its members will not be personally liable for its actions.
  • An LLC can have a somewhat informal management structure.
  • An LLC passes its profits and losses through to the personal tax returns of its owners, so that taxes will be reported at the individual level.

Cons

  • An LLC's members may be subject to self-employment taxes.
  • An LLC is at risk of technical termination, which occurs when its sells or exchanges 50 percent or more of its total interest within 12 months.
  • An LLC must have at least two members in order to gain the tax advantage of a partnership.

Corporation vs. LLC: Similarities and Differences

Liability Protection

Both a corporation and an LLC offer their owners or shareholders protection against personal liability for debts and lawsuits that are related to the business. While the owners' personal assets will be safe should the business face a lawsuit or debt collection action, they may lose the money they invested in the business.

Profit-Sharing and Management

The shareholders of a corporation meet annually and receive a portion of the company's profits based on the type and quantity of shares they own. In an LLC, members own a certain percentage ownership interest, but they can decide how the profits will be distributed. Corporate stock is easier to transfer than LLC membership.

Every corporation has a fixed management structure that includes a board of directors and a group of officers. On the other hand, an LLC does not use a standard management structure. A small LLC can be run informally.

Taxation

A corporation pays income taxes on its profits, and its shareholders pay taxes on the dividends they receive. This is sometimes called “double taxation. In an LLC, members pay taxes on business profits through their personal tax returns. However, they may be subject to self-employment taxes.

Recordkeeping

A corporation is required to hold annual shareholders' meetings. In most states, they must also keep meeting minutes and document important resolutions. In addition, a corporation is required to maintain shareholder records. Some states make it mandatory for them to pay an annual fee and provide an annual report. The recordkeeping requirements for an LLC are significantly less stringent.

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