Incorporating Vs LLC: Everything You Need to Know
Incorporating vs. LLC have several differences. When a business becomes a legal entity separate from its founder, this process is called incorporating.3 min read
What Is Incorporation?
Incorporating vs. LLC have several differences. When a business becomes a legal entity separate from its founder, this process is called incorporating. The incorporation process can result in either an LLC, or limited liability company, or a corporation, which can further be designated as either an S corp or C corp. The benefits of incorporating into either an LLC or corporation include protection from personal liability for business debts and more credibility in the marketplace. Each type of incorporation carries specific advantages and disadvantages.
Limited Liability Company Benefits and Advantages
Forming an LLC protects your personal assets from being seized if your company is successfully sued. The business owner is not held responsible for the actions of the LLC. While corporations must have a specific management structure overseen by a director and administered by officers, LLCs do not require these formalities.
LLCs are also subject to pass-through taxation, which means income and losses are reported on the personal tax return rather than at the business level. This arrangement is typically advantageous for the business owner. An LLC can have any number of owners. This business structure is not required to hold annual meetings or submit meeting minutes.
Characteristics of a Corporation
S corporations and C corporations are primarily distinguished by how taxes are treated for each. An S corp is taxed in the same way as an LLC, while a C corp is taxed as a business entity, not as an individual. If corporate profits are distributed as dividends to shareholders, both S corps and C corps are doubly taxed. Corporations are first taxed on their profits and then on dividends, resulting in double taxation.
Advantages of a Corporation
Unlike LLCs, corporations can issue stock as a means of engaging potential investors. Income splitting can often lower the corporation's tax liability. Corporations are subject to more flexible rules pertaining to profit. Unlike an LLC, where all income is transferred directly to members, an S corporation can pay its members an employee salary from which federal taxes and other expenses are deducted.
The excess profits, after salaries and obligations are paid, are then distributed as dividends. Dividends are taxed at a lower rate than gross income. C corporations can keep profits within the business rather than allocating dividends. This allows the shareholders to determine their most advantageous tax strategy.
Disadvantages of an LLC
LLCs are not allowed to issue stock and cannot lower their corporate tax liability through income splitting. Members are responsible for their own self-employment taxes for the salary and profits they earn. This means they must pay out of pocket for Social Security, Medicare, and other federal benefits.
If an LLC is treated like a partnership for the purpose of federal taxation, it can be automatically terminated. This occurs when more than 50 percent of the company is sold or traded within twelve months, a situation known as technical termination. In the case of a technical termination, assets are transferred to a new LLC and are not taxed.
Statutes that vary by state can cause confusion in LLCs that operate in more than one state. This often triggers more paperwork and different requirements in different areas.
Disadvantages of a Corporation
In addition to double taxation, corporations are subject to extensive paperwork and must meet many legal guidelines. They must:
- Elect a board of directors
- Create and adopt official bylaws
- Hold official annual meetings with recorded minutes
- Develop and submit formal financial statements
S corporations are only allowed a limited number of owners.
Corporation vs. LLC: Liability Protection
Both corporate and LLC structures protect owners from personal liability for business lawsuits and debts. This means that although you may lose money you have invested in the business if one of these situations arises, you will not lose your personal accounts, car, house, and other personal property.
Corporation vs. LLC: Management and Profit-Sharing
Unlike the management structure of corporations as described above, LLCs do not need to adhere to a specific administration structure. This allows for informal management by an owner or group of members. Job titles are not required. Members can agree to distribute profits however they see fit. However, unlike corporate stock, LLC membership is not easily transferable.
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