Is an LLC Incorporated or Unincorporated?
Is an LLC incorporated or unincorporated? This is a common question for people who are trying to understand the legal structure of their business.3 min read
3. What are LLCs?
4. Benefits of Incorporation
5. Disadvantages of Incorporation
6. Differences between Incorporated and Unincorporated Businesses
7. LLCs versus Corporations
Is an LLC incorporated or unincorporated? This is a common question for people who are trying to understand the legal structure of their business. The answer will vary based on what business model you choose. Opting to incorporate can provide benefits in addition to protecting your personal assets from the risk of attachment. It's important to understand the differences between unincorporated and incorporated businesses first. Unincorporated businesses are sole proprietorships or partnerships, while incorporated businesses are corporations. Some states may have specific regulations, but there are general features of incorporated and unincorporated businesses, no matter what state you're in.
Sole Proprietorships and Partnerships
A single-owner business is a sole proprietorship, which is unincorporated. You aren't even required to create a trade name with a sole proprietorship. The IRS requires that you report income and losses, pay self-employment tax, and be personally responsible for business debts.
When two or more people own a business, it's typically a partnership. Each owner is responsible for paying income tax and is liable for debts and activities of the partnership. Each partner is allowed to make business decisions and share any profits.
A corporation registers with the Secretary of State office and it's deemed a separate legal entity from its owner(s). A traditional C corporation is taxed twice — once at the corporate level and then shareholders are taxed on dividends. You can avoid this by electing to become an S corporation, but there are very strict rules on who can apply for this status.
What are LLCs?
LLCs are considered hybrid business organizations as they combine the liability protection benefits of a corporation with the tax benefits of unincorporated businesses. States consider LLCs to be separate entities from its members or owners. The IRS does not consider the LLC to be a separate entity, however. LLCs don't undergo the same process as corporations do, although the requirements are not that different. However, each state regulates LLCs differently.
Benefits of Incorporation
- Personal liability protection
- Tax benefits
- Separate business and personal identities
- Easier to raise capital
- Corporations exist in perpetuity
Disadvantages of Incorporation
- More complex and added paperwork
- Higher costs
- Liability protection is not 100 percent guaranteed if corporate veil is pierced
Differences between Incorporated and Unincorporated Businesses
There are some important areas where incorporated and unincorporated businesses differ. These have to do with taxes, costs, paperwork, and liability.
When you are incorporated, the business owner is protected from personal liability. If the business fails to pay a debt, the creditor cannot attach the owner's assets. If you are not incorporated and don't pay a debt, the creditor can come after your personal assets.
In general, businesses who are incorporated pay fewer taxes than an individually owned business. Corporations also have the option to defer some taxes, which helps with cash flows. There are also additional deductions corporations are privy to. Corporations do have to file separate business tax returns in addition to individual ones, whereas a sole proprietorship files only the individual return. Unincorporated businesses may be able to claim personal tax credits.
Corporations have a longer lifespan as they don't automatically terminate if the owner or a shareholder dies. With unincorporated businesses, you may be required to sell or transfer the business. It is much easier to transfer ownership interests with a corporation because it's a separate legal entity.
Other differences to keep in mind:
- You can also use any businesses losses to offset personal tax income and liability.
- Corporations have ongoing costs that unincorporated businesses don't.
- Paperwork is more complex for corporations.
- You are also required to prepare quarterly and annual reports for the government.
LLCs versus Corporations
Advantages of an LLC:
- There is no limit on how many owners you can have.
- It's treated as a pass-through entity so income and losses are passed along to the individual owners to report on their tax returns.
- There is not a requirement to keep minutes or hold annual meetings.
Advantages of a corporation:
- Corporations can issue stock to raise capital and attract investors.
- Income splitting in a corporation may help lower overall tax liability for the business.
Disadvantages of LLCs:
- There is no ability to split income to try and lower tax liability.
- LLCs cannot issue stock to help raise capital.
Disadvantages of Corporations:
- There are double-taxation issues with traditional C corporations, although S corporations do not face these.
- Corporations must hold annual meetings and keep detailed minutes of each.
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