If you are wondering whether to form an LLC or an INC, here is what you should know.
Both are formed by filling forms, they provide limited liability protection for owners, are different types of business entities, and are different in the way they are managed, owned, and taxed. In addition, you can check out how Limited Liability compares to Partnership in our LLC vs LLP review. Moreover, you can decide on how to structure your business after reading our C Corp vs S Corp, or S Corp vs LLC comparison.
Keep reading this LLC vs INC review to learn all their differences. Bear in mind that LLC formation is easy compared to INC formation. In addition, if you are on a tight budget, look into our Incfile review, and should you need online advocates services, check out our Rocket Lawyer review, or Nolo Review.
LLC vs INC - Which Is Better for Your Business?
What Is an LLC?
LLC stands for Limited Liability Company. This is a type of business that protects its owners from being liable for its debts. It is a popular choice among many entrepreneurs ( look at how to become an entrepreneur here) because of its tax advantages (see 'When Are LLC Taxes Due?' post), is easy to form, and has flexible management. Also, it's important to know the differences between companies and businesses so you can understand what you're setting up and to come up with a best possible idea for your business.
It is important to understand the advantages and disadvantages of a limited liability company (see our detailed post on LLC benefits) in order to decide if it is right for your business or not. Starting your own LLC is easy, but buying an already established business is worth considering, too, as explained in this post.
1. Select the state that you want to set up your LLC
2. Name your limited liability company
3. Select your registered agent
4. Submit articles of organization. It also called the certificate of organization or certificate of formation in some states
5. Submit an LLC operating agreement. Some states do not require this document
6. Apply for an Employer Identification Number (EIN)
LLC owners are called members. It has a flexible membership. Members can be from trusts, other LLCs, individuals, banks (find out more about top banks for small businesses), just to name a few. There is also no limit on the number of members - see this comparison for more on the matter.
In LLC, members manage the LLC, unlike corporations that require shareholders to elect a board of directors to make decisions on behalf of them - see LLC vs Corporation here. LLC pays only personal income tax, it does not pay tax at the entity level.
A corporation pays corporate tax and personal income tax - see our small business tax guide here.
What Is a Corporation?
When a business incorporates, it automatically becomes a C Corp or a C corporation. An incorporated company is also referred to as a corporation and is abbreviation Inc - see all about rules and regulations when incorporating.
The owners of a corporation are called shareholders. Shareholders must elect a board of directors to make major decisions on behalf of them.
It’s a separate entity from its owners. It can sue and be sued, have its own assets, and can enter into contracts. It also pays corporate tax. It offers limited liability protection for its shareholders hence they are not held responsible for its debts and liabilities.
Types of Corporations
There are 2 types of corporations; a C Corporation and S Corporation. Their key difference is how they are taxed. C Corporation has double taxation while S corporation pays only 1 tax.
Which Is Better a Corporation or an LLC
I would recommend a limited liability company or LLC. It is easy to form, it has tax advantages, and members can be individuals, entities, or foreigners, has fewer state regulations and offers limited liability protection.
Incorporation vs. LLC – Separate Entity Status
LLC is just like a corporation. Both are separate legal entities that can enter into a contract, sue, and be sued even go into bankruptcy without dragging their members.
As you can see, An LLC shares some characteristics with a corporation; both are separate legal entities. Also, both business entities offer limited liability protection for their owners.
This means that no member is liable for the debts of either LLC or corporation. If you need an online advocate check out two of the best registered agent services in this post.
LLC vs. Inc. – Formation
Setting up your LLC
Decide which state to set up your business, name your LLC, select a registered agent, submit your articles of organization, submit an LLC operating agreement and the final step is applying for an EIN or employer identification number.
State of formation
When choosing the state to form your business, make sure it is where you plan to conduct your business or where your customers are. It does not make sense to set up your business in Minnesota and yet your customers live in another state.
Naming your business
Choose a unique name for your business. It must include the abbreviation LLC or the phrase limited liability company. It should not include government names such as treasury, FBI, etc.
Select a Registered Agent
You must have a registered agent when forming an LLC. This is a person who will be receiving important legal documents on your behalf from your state then forward it to you.
Filing important legal documents with your state
When forming an LLC, you are required to write articles of organization and operating agreement. You can create your own documents or can seek the help of an online legal services company.
The Articles of organization have basic information about your LLC such as an address, business name, purpose, just to mention a few. An operating agreement is another crucial document needed when forming an LLC.
It contains detailed information about how the business will be run, members of the LLC, capital contributions, etc.
Application for EIN
This is needed by banks when opening a business bank account plus when hiring employees.
There are several steps you need to take in order to form a corporation. The formation process for a corporation is lengthy compared to LLC.
Naming your corporation
Find a suitable name for your Inc. It needs to be unique and should not contain names such as insurance and bank.
Select a state to incorporate in
The second step is choosing the best state to incorporate your business. There are various factors to consider when choosing a state for your business such as corporate laws, tax rates, cost of forming a business, etc. It is recommended to form your business in your home state or where you conduct your business most.
A corporation is required by law to have directors. They are typically elected by owners to run the corporation.
File Business documents
In order to form a corporation, you will be required to file articles of incorporation and write corporate bylaws. Articles of incorporation contain basic information about the corporation such as type of stock issued, business name, street address, and many more.
Some states require corporate bylaws. This is a document that specifies the duties of directors, officers, and shareholders. Confirm if your state requires corporate bylaws.
Hold the first board of Directors meeting
The directors are needed to hold an initial meeting so as to discuss important things and present important documents so everybody can know their roles and salaries. Minutes should be taken and authorize the issuance of stock.
Once the board of directors authorizes the issuance of stocks, the share certificates can be prepared then issued. Note down who owns the share and how much. The cash from the share can help finance the corporation.
Obtain required permit and license
Permits and licenses are required in order for the corporation to conduct business. Check with your state the requirements needed to obtain license and permit.
LLC vs. Corporation - Limited Liability Protection for Owners
Both LLC and corporations provide limited liability protection for owners. If you want to protect your assets from creditors, you can form either an LLC or a corporation. Both are separate entities from their owners.
If both businesses are unable to pay their debts, creditors can only claim their assets but not homes and cars of the owners.
LLC vs. Inc. for Taxation
If you are a small business person just starting out - see small business grants here - the best decision you should make when setting up your business is selecting a structure that is tax-friendly (see our guide on business structures). LLC does not pay federal income tax. Also, non-profits should read our CharityNet USA reviews.
Instead, tax is paid at the individual level. The owners pay the tax, a percentage of the profits from the LLC.
Corporation taxation is different. Corporations pay tax at the entity and individual level. This applies to C corporations. A-C Corporation is a separate taxable entity that is required by law to pay corporate tax.
Shareholders are also required to pay a personal income. This is a percentage of dividends or profits they get from the corporation. Keep in mind that a C Corporation can convert to S Corporation in order to avoid double taxation.
Although it pays tax at the individual level only, an S corporation may not be a popular choice for many people because it has to meet strict requirements which include:
- Shareholders must not be more than 100
- They should not be foreigners. Only USA citizens or residents are allowed to form an S corporation
- There should be only 1 class of stock
These are federal tax rules but not corporate laws.
LLC can choose how it wants to be taxed. It is taxed as a sole proprietorship if it has 1 member and as a partnership, if it has more than 1 member (see our 'LLV vs Sole Proprietorship' post). An LLC can also choose to be taxed as C Corporation or S Corporation.
LLC is considered a pass-through business hence owners pay personal income tax. The net income for the LLC is given equally to members who each will pay tax.
Let’s say an LLC with 3 members made $120,000 and is profit after deducting expenses from the income of the LLC. Each member will receive $40,000. This share will be used to determine how much tax should be paid.
Unlike a limited liability company, a corporation pays taxes at the corporate level plus its shareholders are required to pay taxes after receiving dividends. This means that the corporate income is taxed plus the dividends that are given to shareholders.
This is referred to as double taxation. As you can see, these are the disadvantages of operating a C corporation. A-C Corp can evade this by converting to an S Corp which pays only tax at the individual level.
LLC vs. Inc. – Registered Agent Compliance
When you set up a business like an LLC or a corporation, you need the services of a registered agent. In some states, the agent can also be called a resident agent, a statutory agent, or agent for service of process.
This is a person who receives important documents on your behalf from the secretary of state then delivers it to you. He or she will also help you maintain corporate compliance by making sure you receive legal notices on time.
Expect your registered agent to receive the following documents and reminders on your behalf:
- Annual report filing reminders
- Tax forms
- Notice of a lawsuit
- Important business documents
LLC vs. Inc. for Management
An LLC is managed by its members. All the members take part in the decision making process. Members can hire a management team to manage the LLC on their behalf.
They can also elect a member to serve as a manager. In this instance, the manager gets dividends from the LLC earnings and also receives a salary as an employee of the LLC.
If the LLC members decide to hire a non-member manager, this person is eligible for an employee salary.
The above duties and responsibilities should be clearly indicated in the employment contract and in the LLC's operating agreement.
Corporations are run by a board of directors who make major decisions about the business. Their roles include approving the corporation’s financial statement, pay dividends, hire and fire senior executives, set goals for the business, create option policies, and many more.
The directors are elected by the shareholders from inside or outside the company. Corporation Bylaws govern how many board members should be, how they should be elected, and how they should be meeting.
Shareholders in a corporation have limited management roles compared to an LLC. This is because LLC is managed by its members while a board of directors manages a corporation.
LLC vs. Inc. for Ownership
The owners of an LLC are called members. An LLC can have 1 member or unlimited number of members. They can include foreigners, come from other trusts or corporations.
Each member’s ownership share is determined by their capital contribution which can be either in cash or property based on agreed market value.
Also, members can contribute as much as they want in capital contribution but this should be done according to the terms of the LLC operating agreement.
C Corporation Ownership
C-Corporations are more common in the United States; with unlimited growth potential, ability to sell equity to raise capital, and no limit to the number of shareholders they can have. However, double taxation, increased state regulations, and formalities make them less desirable.
A corporation is owned by shareholders. Although they are not involved in the daily business operations of a corporation, they are the ones who elect a board of directors who become overseers of their investment.
A corporation is managed by a board of directors who make major decisions of the corporation. They can hire and fire employees and even allocate resources.
Shareholders earn a dividend per share; the dividend is usually paid out in the form of cash to the investors. There are other types of dividend payments.
In LLC, members receive a bigger dividend per share whereas in corporations each shareholder receives a fixed dividend per share.
As the owners, some shareholders may want to participate in the decision making, inspect audit reports, and even take part in strategic planning.
LLC vs. Inc. for Classes and Transferability of Interests
LLCs have restrictions when it comes to transferring interests between members; this would be prohibited in case it would put the company in a financial crisis.
A member should seek approval from other members, be it orally, in writing before proceeding to request the transfer of member interests. To put it simply, the transfer of shares is allowed but it should be done under the LLC operating agreement.
In addition, LLC can buy back interest from its members. However, the laws might vary from different states regardless of the LLC operating agreement and that is why it is recommended to involve a business attorney in your state to help with the transferability of interests.
A corporation allows easy transfer of shares
On the other hand corporations allow the swift transfer of share within members. However, some corporations restrict the transfer of shares so it is wise to look carefully at a corporation operating agreement before making any investment.
In comparison to an LLC, it is easier to transfer shares in a corporation making them more appealing to external investors.
LLC vs. Inc. for Recordkeeping
When you are running a business, it is important to keep records. However it is easy to lose interest and overlook this critical administrative role.
In addition to being the best business practice, record-keeping is essential for planning and prevents legal penalties. LLCs and corporations are required by law to keep records.
There are various records that a corporation or an LLC should keep that could save them from lawsuits or being accused of not operating within the proper formalities of corporate state laws.
Some of the records that they keep include business ledgers, tax forms, annual reports, members, and shareholders list.
These records are kept in a file cabinet or in a secure online server that can be accessed easily to prove that the company has been functioning as required by laws hence keeping internal revenue service in check.
LLCs have easier record-keeping than corporations. They do not hold annual meetings hence no many report requirements though there are still important record formalities that must be observed to retain the liability status.
LLC vs. Inc. - Making Your Choice
When starting a business, it is important to consider the type of business you will form, putting into consideration the legal requirements, tax advantages, ease of formation, management, just to mention a few.
It is recommended to seek professional guidance when forming your business.
LLC and corporations offer owners similar liability protection, protecting them from lawsuits and debt hence can focus on other things such as closing more sales.
C Corporations are a common type of business in the United States because of their separate legal entity that protects owner assets from creditors’ claims.
However, they are subjected to double taxation. Taxation is done at the corporate level and then at the personal income tax level.
I would recommend an LLC because it is easy to form, offers limited liability protection to its owners, and has no double taxation. Its members do not pay corporate tax, instead, they pay only personal income tax.