When choosing a legal entity for your business, it’s important to consider a few factors, such as the size of your business, the formation costs of a given business structure, its taxation policies, and the management options. If you can’t decide whether an LLC or an incorporated entity would suit your business best, then our article is for you.
In this article, we’ll provide an answer to the common question: “What is the difference between an LLC and an Inc?”. We start off by explaining what it means for a business to be incorporated. Afterward, we move onto separate sections wherein we detail how these two entities differ in terms of taxation, formation, ownership, management, and fees. At the end of our article, you’ll find an FAQ section where we provide answers to some pressing questions related to LLCs and incorporated businesses.
Without further ado, let’s get started.
What Does It Mean for a Business to be Incorporated?
It can be hard to distinguish between these two business entities, so let’s start by explaining what it means for a business to be incorporated.
When a sole proprietorship or a partnership is incorporated, it becomes a company that’s recognised on a state level. Similarly, incorporating a company signifies that it’s formally known as a separate entity with the state and the IRS. In other words, the company becomes its own business structure separate from the members who own the business. In order for this to occur, a company has to provide necessary legal documents and go through various steps.
There are many benefits that come with incorporating a business. One of the main benefits you can expect to get from this change in structures is limited liability. All the owners of the company won’t be held personally liable in case of a claim, debt, or a lawsuit. Their personal assets will remain protected regardless of what happens to the business. Once you incorporate your business, you will only be held responsible for the money you personally invest into it, all the while your personal assets will be untouchable.
An incorporated business can be created by an individual or a group of people who share the same vision regarding the future of the business.
Now that we defined what it means for a business to be incorporated, let’s define what an LLC is so you can easily distinguish between the two.
What Is an LLC?
An LLC stands for Limited Liability Company. It’s a business structure that equips its members with limited liability so that they won’t have personal responsibility for any debts or losses. LLCs have a particular taxation policy which we will explore below.
Every state varies in terms of LLC regulations, which is why it’s important to do thorough research before you decide to form an LLC in any state.
With that out of the way, let’s move on to exploring the main differences between these two business structures.
LLC vs. INC – Taxation
One of the main differences between an LLC and an Inc. is their taxation policies.
LLCs qualify for pass-through taxation, which essentially means that the owners don’t have to pay federal income tax, but both the profits and the losses of the business are taxed on the owners’ personal income. LLCs don’t have double taxation, unlike some other business structures, so the business itself doesn’t pay any corporate taxes.
Moreover, LLCs have a lot of flexibility when it comes to taxation, so much so that members can choose how they want their LLC to be taxed. If an LLC chooses to, it can apply to be taxed as a corporation under Subchapter C.
On the other hand, because corporations are seen as separate legal entities that earn their own income, they have double taxation, i.e. their income is taxed both on a federal and personal level. Dividends are also taxed twice since they are not tax deductible like some other income, like yearly bonuses. The double taxation is one of the main drawbacks of forming a corporation and it’s a common reason why many entrepreneurs opt for an LLC.
There are, however, some redeemable sides to corporate taxation. For instance, a corporation has the option to deduct all business-related expenses, such as rent, transport, and equipment. Additionally, it also includes an employee’s medical or retirement plans. Needless to say, these expenses add over time, so you’re bound to save a considerable sum of money.
Similarly to LLCs, corporations can decide whether they want to be taxed as a C corp or as an S corp. If a company has less than 100 shareholders, it automatically classifies to be taxed as an S corp. S corps can have pass-through taxation, giving you the favourable taxation policies of an LLC with a more complex and formal business structure, so many entrepreneurs opt for this option.
LLC vs. Inc – Management
Similarly to taxation, LLCs and incorporated businesses also differ in terms of management. There are several crucial documents that are compiled at the formation process of each business structure: Articles of Organization and a formal operating agreement for LLCs, and Articles of Incorporation and bylaws for corporations.
In this regard, LLCs have much more flexible management options. There are two main distinctions when it comes to LLCs and management: they can be manager-managed and member-managed. Manager-managed LLCs appoint an outside person to handle all the business-related decisions in the company. In member-managed LLCs, the members have the role of managers and they are responsible for making the day-to-day decisions relating to the business. There are some benefits to this kind of structure; for instance, LLCs don’t have to hold annual meetings.
As opposed to LLCs, corporations have a much stricter management structure. They’re obliged by law to select a board of directors who are responsible for the management of the business. In addition, they also have corporate officers who are in charge of the day-to-day decision-making, while the shareholders don’t actively participate in the management or decision-making in the business. Despite their passive participation, they have a say in which directors and officers are elected.
In addition, corporations are obligated to hold annual shareholder meetings, directors’ meetings, and other formal duties.
We’ll continue our comparison by discussing how LLCs and corporations differ in terms of ownership.
LLC vs. Inc – Ownership
The ownership of a corporation is based on the number of stocks each shareholder has. The dividends given are always of equal value. Shareholders can choose to sell off their stock or purchase more stock to own a larger percentage of the company.
In LLCs, members can choose to state different ownership rights in the operating agreement, giving some members a larger percentage of profit than others, depending on their contribution to the business. This allows for a lot of flexibility in terms of dividing the ownership of the business.
Additionally, there are no restrictions in terms of how many owners an LLC or a corporation can have.
LLC vs. Inc – Formation
It’s important to get acquainted with the formation procedures of each business structure prior to deciding on one. In this section, we’ll explore some of the key differences between the formation process of LLCs and Inc.
Creating an LLC is a much easier and simpler process than creating an incorporated business. You don’t have to contend with large piles of paperwork or have a myriad of obligations to complete each year. With that said, the process of forming an LLC depends on the state where your LLC is located. There are a few obligatory processes you have to go through regardless of the state you’re in, such as filing articles of organization.
Despite not being obligatory, most businesses decide to create an operating agreement because it makes running the business easier and it’s a prophylactic measure against conflict. In an operating agreement, you usually include information such as the responsibilities of each member and the distribution of the losses and profits for each member.
As you can imagine, forming a corporation is slightly more burdensome than forming an LLC due to the complexity of the structure. Apart from going through some standard steps, like choosing a name for your business and registering with the state, you also have to appoint a board of directors, draft a shareholder agreement, and issue the initial stock.
LLC vs. Inc. – Fees
It’s also important to consider the differences in the number of fees you have to pay on a yearly basis and during the formation process for each business structure.
Inc. businesses are obliged to pay a registration fee ranging anywhere from a hundred dollars to a thousand dollars, depending on the state where you’re conducting your business. Additionally, corporations have to file annual reports, which typically cost around $125.
Depending on the type of business you’re conducting, you might also have to obtain a licence or a permit at the beginning. The license fee varies from state to state, but, on average, it can cost anywhere between $50 and a couple of hundred dollars, in addition to the renewal fees.
When it comes to LLCs, the fee cost is significantly lower. The majority of the fees LLCs have to pay are during the formation stage of the business. Unlike incorporated businesses, they don’t have as many annual responsibilities, which contributes to a lower overall cost. They do, however, have to file annual reports, so consider that as well when deciding between an LLC and an Inc.
Here are some of the remaining differences between an LLC and an Inc.
- An Inc. can issue shares, while an LLC doesn’t operate with shares.
- LLCs are better for smaller businesses or medium-sized businesses, while larger businesses would suit the structure of Inc. a lot more.
- If a member of an LLC dies or decides to quit, it will affect the management of the LLC. However, the death of a shareholder wouldn’t have an impact on the structure of the corporation.
- LLCs don’t require a lot of paperwork, whereas corporations have to complete a lot more paperwork on a yearly basis.
How to Incorporate a Business
Here are some of the crucial steps you need to take to incorporate your business.
Choose a Business Name
As you can assume, the first step in incorporating a business is picking a name. The one thing you should keep in mind during this process is that the name has to be unique – you can’t take a name that’s already used by another company. To help you in this process, we recommend conducting a trademark search or using a search engine to see if the name appears anywhere. Your name can be numbered or made up of letters.
When you’ve ensured that the name you’ve chosen is completely unique and that it doesn’t show up anywhere in the database, the next step is to reserve the name to prevent another company from claiming it.
File Articles of Incorporation
Another obligatory step in incorporating your business is filing articles of organization. This includes gathering and filing all the necessary paperwork for your business to become registered with the Secretary of State.
The document and legal requirements vary from state to state, so you have to check with the state where you want your business to be located. If you want, you can always hire a legal consultant to help guide you through this step.
The articles of incorporation typically contain information such as the name of your business, its location, the reason why you’ve decided to form your business, and the names of the members.
Once you file your articles of incorporation, they’ll need to be approved by the Secretary of State. Keep in mind that, in every state, you have to pay a certain fee for this process to be completed, so include the approximate fees in your estimated formation budget.
Appoint a Board of Directors
When your business application is approved, you’ll need to appoint a board of directors to get the operations of your business started.
As we mentioned earlier, the board of directors oversee the operations of your business and help with creating strategies for your business. There are some eligibility requirements you need to comply with when appointing a board of directors; for instance, you’ll need at least three board members and you’re required to conduct annual meetings.
Write Up Bylaws
The final step in incorporating a business is writing up your corporate bylaws. This is a document that states how your corporation will be managed moving forward. It includes information about the shareholders, the annual meetings, taxation, and shares.
Since this is a much longer and more intricate document than the articles of incorporation, consider hiring legal help to ensure that your document is well-crafted. Bylaws aren’t necessary for every state, but most corporations find them indispensable in helping clarify managerial duties.
What Is Better for a Small Business, LLC or a Corporation?
Small businesses can form both an LLC and a corporation. As a small business owner, you might want to start with an LLC if you don’t have a large budget to work with or if you don’t have a lot of experience. LLCs are significantly easier to manage and form than corporations. Needless to say, if you think you can manage a corporation, then there’s no reason why you shouldn’t give it a go.
What Is More Expensive to Set Up: an LLC or a Corporation?
Taking into account the formation fees of each business structure is incredibly important when you’re trying to figure out which structure would work well for your business. On average, LLCs are much more affordable to set up than corporations – they come with fewer formation fees and they also have fewer fees on an annual level. So, if you don’t have a large budget when you’re starting your business, LLC is the safer option.
Does an LLC Require More Than One Member?
No, you can form an LLC with only one member/owner. There are no legal requirements in terms of the minimum number of members it should have.
We hope you found this article useful and that by now you know the difference between an LLC and an Inc.
LLCs and corporations differ in various ways, but the main differences lie in the way these entities are managed and owned, their taxation policies, and the formation process of each business. There are also some other minor differences between these entities – LLCs have significantly less paperwork than corporations, but they are also a lot more vulnerable in case a member dies or decides to leave the business.