LLC vs Inc vs Corp: Everything You Need to Know
Debating between LLC vs. Inc. vs. Corp status? Many entrepreneurs wonder what incorporation structure to choose when starting a new business. Understanding your options can be overwhelming, especially if you've never opened a business before.4 min read
Debating between LLC vs. Inc. vs. Corp status? Many entrepreneurs wonder what incorporation structure to choose when starting a new business. Understanding your options can be overwhelming, especially if you've never opened a business before.
An Overview of Incorporation Options
You've probably noticed many businesses end with an LLC, Inc., or Corp. abbreviation, but what does this mean? The abbreviations indicate different types of business entities.
LLC stands for “limited liability company.” Both Inc. and Corp. refer to a corporation. Whether you have an LLC or a corporation, both business structures are formed by filing state-required documents. Both structures also protect their owners from business-related obligations and liability, such as debts and lawsuits.
LLCs and corporations, however, are managed, owned, and taxed differently. They have different reporting and recordkeeping requirements. Therefore, it's important not to mix up the two concepts.
Remember, there is a distinction between a legal entity and a tax entity. Legal entities include LLCs and corporations, while tax entities are:
- Sole proprietorships
- C corporations
- S corporations.
The legal entity is how the state, courts, and contractual partners see the business, while the IRS and the state taxing board use the tax classification.
If you own a corporation, it will be given either a C corp or an S corp tax status. If you have an LLC, you can choose to be a sole proprietorship or a partnership, or as a C corp or an S corp for tax purposes. As such, an LLC has a great amount of flexibility.
What Is Incorporation?
Incorporating a business is when it becomes a legal entity of its own, separate from the owners. When choosing a new business structure, you have two categories to choose from: LLC or corporation. There are certain benefits to consider before deciding which structure is right for your business. Either option protects you from personal liability and gives your business credibility within the community.
Of course, not all incorporation options are equal, so disadvantages do exist. When considering which option is best, think about your company's short- and long-term goals.
The Importance of Liability Protection
Both LLC and corporation owners are protected from personal liability for lawsuits or business-related debts. For example, if the company is sued, your personal assets are protected, including:
- Your car
- Your home
- Your personal bank accounts.
The only thing you stand to lose is the money you invested in the business.
Since you receive the same type of liability protections with both an LLC and a corporation, one isn't necessarily better than the other.
Management and Profit Sharing
LLCs and corporations differ in how they're managed and how profits are dispersed. Corporations have a predictable management structure that's standard across the board. Every corporation must have:
- Shareholders who own stock in the business
- Officers who run the company
- A board of directors.
The shareholders must meet every year, and the company distributes profits to them based on the type and number of shares they own.
LLCs don't have a predictable management structure. In fact, they can be owned by a single owner or by a group of owners, who are referred to as “members.” These individuals aren't required to have specific job titles, and the LLC can operate informally compared to a corporation.
Each LLC member does own an interest percentage in the business. However, profits are distributed according to however the members agree to distribute them. The downside is that memberships aren't easy to transfer like with corporate stock, which can be a drawback to some owners.
Due to its share transferability and uniform management system, a corporate structure is preferred by investors over LLCs. However, most small-business owners who don't need outside capital tend to prefer the simplicity and flexibility LLCs offer.
Corporations can be taxed as either an S corp or a C corp.
An S corp:
- Doesn't pay corporate income tax.
- Passes profits through to shareholders.
- Requires shareholders to pay personal income tax on profits.
A C corp:
- Pays corporate taxes on profits.
- Requires shareholders to pay personal income tax on dividends, resulting in double taxation.
LLCs, by contrast, do not have their own tax classification. An LLC can choose S corp or C corp status if it qualifies. However, usually LLC members are taxed as if they were sole proprietors or partnerships. An LLC's expenses and income are reported on each member's income taxes, and each member pays taxes on his or her share of the profits earned.
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