LLC vs. Inc.: What Is the Difference Between Them?

Are you contemplating the ideal business structure for your new venture? While both limited liability companies (LLCs) and corporations (inc.) provide limited liability protection and similar legal entities, the choice between the two can significantly affect your business' growth and success.

Let's dive into the key similarities and differences between LLCs and corporations, exploring their unique benefits and drawbacks—essentially, the “LLC vs. inc." debate. By the end, you'll be better equipped to make an informed decision on the ideal business structure for your needs.

Fast facts: LLC vs. inc. 

• Corporations and LLCs both protect company owners from personal liability for business obligations.
• Both LLCs and corporations are governed by the laws of the state where they are formed.
• It’s easier and faster to form an LLC than a corporation, which involves appointing a board of directors and creating corporate bylaws.
• An LLC can choose how they wish to be taxed—as a pass-through entity where the business income passes on to the owners' personal tax returns or a corporation. 
• With a corporation, profits are taxed at both the corporate and individual shareholder levels, requiring them to pay personal income taxes. This is known as double taxation.
• It’s more expensive to incorporate due to additional legal expenses and higher filing fees.
• A corporation has a formal management structure, as the board of directors steers the direction of the company. LLC owners can choose their level of involvement and form a structure according to their business needs and goals.

Understanding business structures

A business structure is the legal framework of operations that’s recognized in a certain jurisdiction. Choosing the right entity type is essential. This decision impacts everything about how you run your small business.

A business can adopt any of the following types of structures: 

• Sole proprietorship
• Limited liability company
• Partnership
• Corporation

Aspiring entrepreneurs often face the critical decision of choosing between an LLC and a corporation as their preferred business structure. Both are separate legal entities that offer limited liability protection to their owners, shielding personal assets from business debts and lawsuits. However, they differ in several aspects, including management, ownership, and taxation.

What is a limited liability company? 

An LLC is a business structure that offers flexibility and control of sole proprietorships while providing personal liability protection. When you form an LLC, your personal valuables, such as your home or savings account, are safe from business debts and liabilities. This is because an LLC is considered a separate legal entity from its owners (known as members).  

Furthermore, LLCs typically enjoy pass-through taxation, with profits and losses reported on the members' individual tax returns, avoiding the double taxation faced by corporations.

LLCs also boast an adaptable management structure, enabling members to either self-manage the business or appoint managers for daily operations. This flexibility, combined with the tax advantages and limited liability protection, makes LLCs an attractive option for small businesses and startups.

What is a corporation (inc.)? 

A corporation, also known as a “Corp.” or “Inc.” is a more formal and structured legal business structure where the business entity is separate from its owners. Owned by shareholders, corporations must adhere to stricter legal requirements and regulations compared to LLCs, such as holding annual shareholder meetings. 

The shareholders elect a board of directors responsible for managing the corporation's affairs, creating a clear separation of ownership and management. Therefore, even if a shareholder decides to sell their stock to someone else, a corporation continues to exist and do business. 

Another beauty of forming a corporation is that it gives its owners the highest level of liability protection. The owners, or “shareholders,” are shielded from the corporation’s debts and liabilities. However, in unique circumstances, like fraud or failure to comply with corporate compliance requirements, the corporate veil can be pierced, and the stockholders can be held personally liable.

Corporations face the issue of double taxation, with profits taxed at the corporate level through corporate income tax and then again when distributed as dividends to the corporate shareholders themselves. To avoid this, some corporations can elect to be taxed as S corporations, allowing for pass-through taxation similar to LLCs.

Despite the more rigid structure and potential tax implications, corporations can be an ideal choice for larger businesses seeking to raise capital and attract investors.

Key differences between LLCs and corporations 

The biggest differences between an LLC and corporations are the formation process, management/ownership structure, and taxation methods. Recognizing the key differences between the two can aid in making an informed decision about your business structure.  

Formation and legal requirements

The formation process for LLCs and corporations involves distinct steps and legal requirements. To form an LLC, one must file the articles of organization with the respective Secretary of State (SOS). In some cases, you may have to draft an operating agreement that outlines the management and ownership structure of the LLC or issue a public notice. You can do this on your own or offload the paperwork headache to a business formation company like LegalZoom. Our directory of business lawyers can simplify the LLC registration process for you. 

Forming a corporation requires filing articles of incorporation, selecting a board of directors, and submitting corporate bylaws. 

As part of their formation paperwork, both entities need to appoint a registered agent, select an available and legally appropriate business name, and pay the stipulated fees. Your state's Secretary of State website is the best resource for understanding your state's specific formation requirements.

While both business entities are subject to compliance requirements like filing annual reports and renewing appropriate licenses and permits, corporations typically face more stringent legal requirements and record-keeping obligations. For instance, transfer of corporate stocks may require additional regulatory compliance, and their financial statements may undergo more audits.

Management and ownership 

The management and ownership structures also differ between LLCs and corporations.

Here’s how LLCs are owned and managed. 

• Ownership. LLCs have members with ownership interests in the company. These members can be domestic or foreign individuals, corporations, partnerships, or trusts. An operating agreement  is useful to define membership interests, outline ownership transfer process, and specify what happens when a member leaves. 
• Management. LLCs offer a more flexible management structure, allowing members to either manage the business themselves or appoint designated managers. This adaptability can be advantageous for small businesses and startups that require more control over their day-to-day operations.

Corporations, on the other hand, are owned and managed differently. 

• Ownership. Corporations have shareholders who own stock in the corporation and generally offer more straightforward methods for transferring shares and changing ownership. If a shareholder sells their stake, the corporation doesn’t dissolve. The ability to transfer ownership through the sale of shares also simplifies the process of business succession and attracting new investors.
• Management. Corporations follow a more rigid structure, with shareholders electing a board of directors responsible for overseeing the company's affairs.

Taxation

When deciding between an LLC and a corporation, taxation is a key factor to consider because it impacts your bookkeeping and bottom line. 

From a tax standpoint, LLCs: 

• Are not viewed as an independent entity by the Internal Revenue Service (IRS).
• Benefit from pass-through taxation.
• Have the flexibility to choose their tax filing status.
• Allow profits and losses to flow through to the individual members' tax returns, avoiding double taxation.
• Can be particularly advantageous for small businesses and startups seeking to minimize their tax burden.
• Members pay income and self-employment taxes, which is currently at 15.3%.

Some LLCs prefer to be taxed as C corporations because then only salaries paid to owners and employers are subject to self-employment taxes. Other earnings are treated as dividends and are exempt from Self-Employment Contributions Act (SECA) Tax.

On the other hand, a corporation: 

• Is viewed as a separate taxable entity by the IRS.
• Has to pay taxes on profits and dividends. Current corporate taxation rate is 21%.
• Have certain federal deductions available only to them, such as carrying back net operating losses (NOLs) for two years.
• Requires shareholders to pay personal income taxes.
• Can elect S corp status to enable pass-through taxation and avoid double taxation.

LLCs and corporations, with only one class of stock and under 100 shareholders, can opt to elect an S corp tax filing status.

S corporations: 

• Have pass-through taxation and are taxed only at personal income level
• Don’t have to pay taxes on dividends if it doesn't exceed stock value
• Are exempt from federal corporate income tax 
• Have to pay employment taxes only on salaries paid to owners and employees

Reporting and record keeping

Both LLCs and corporations are governed by the laws of the state where they are formed. Each state has its own set of rules about the records businesses must keep and the regular reports they must file with the state.

Corporations are usually required to hold an annual shareholder meeting, and they must give notice of that annual meeting in the way described in the bylaws. Certain actions must be confirmed in resolutions that are kept in corporate minute books. Most states require corporations to file annual reports and pay an annual fee or franchise tax.

Compared to how corporations operate, LLCs have more flexibility in the way they do business. For example, LLCs typically don't have to hold member meetings under state law, but the LLC's operating agreement may require them. LLCs often have fewer record-keeping requirements than corporations. But like corporations, LLCs must file an annual report form accompanied by an annual report fee and/or franchise taxes in many states.

Pros and cons of LLC vs. Inc.

Both LLCs and corporations come with their unique pros and cons. The following sections further investigate the benefits and drawbacks of each business structure, offering valuable insights to guide your decision-making process for your venture.

Advantages of an LLC

LLCs offer several advantages that make them an attractive option for many business owners, with the primary ones being: 

• Provides limited liability protection. The members' personal assets are safeguarded. 
• Allows for pass-through taxation. Owners aren't tied to one particular tax classification and can choose how they wish to be taxed based on their business setup and needs.
• Provides flexible management structure. Owners can maintain direct control over the business's daily operations and membership interests.
• Ease of formation. Forming an LLCs simply requires you to file business formation documents state’s SOS. With LegalZoom’s Business Formation Services, you can get your approval as quickly as a few days.
• Scaled down compliance and record-keeping. LLC owners aren’t mandated to have annual meetings or keep detailed records. 

Disadvantages of an LLC

Despite the numerous benefits of an LLC, there are some potential drawbacks to consider:

• Potential for higher self-employment taxes due to the pass-through taxation system
• Profit distribution system of an LLC can make it less appealing to investors
• Transferring ownership interests in an LLC can be more complex than in a corporation
• Poses challenges when it comes to business succession planning

Advantages of a corporation 

Corporations also offer a range of advantages for businesses, including: 

• Limited liability protection
• Easier transfer of ownership
• Potential tax benefits for certain businesses
• More formal structure 
• Clear separation between owners and management 
• Easier to raise capital and attract investors
• No restriction of ownership; can have as many shares as desired
• Perpetual existence

If a corporation that qualifies as an S corp, they are able to: 

• Avoid double taxation because they don’t have to pay federal corporate taxes.
• Have a simplified transfer of interest process.
• Get tax free dividends.

Disadvantages of a corporation 

While corporations offer numerous benefits, there are also potential drawbacks to consider. Some of the most significant disadvantages are: 

• Being subject to double taxation which can result in a higher tax burden for the business owner and its shareholders.
• More stringent legal requirements and regulations compared to LLCs, which can increase the complexity and cost of operation.
• More rigid management structure, which may limit the flexibility and control of the business owners.

There are also a few limitation to being an S corp, such as: 

• Being subject to approval. You have to submit a Form 2553 with the IRS before you can file as an S corp. This process may involve more fees. 
• Facing higher scrutiny from the IRS. The IRS is known to keep a closer watch to identify any company disguising salaries as dividends to avoid paying additional taxes. 
• Limits growth. S corps are only allowed a maximum of 100 shareholders.

What is the difference between a C corp and an S corporation? 

The difference between an S corp and C corp involves the way they pay taxes under the Internal Revenue Code. All corporations are C corps unless they elect a different status. There are crucial differences between the two. It’s best to view an S corp as an entity with a special tax status with the IRS. S corps, unlike C corporations, avoid double taxation because they don’t have to pay corporate-level income taxes. Corporations also have more formal compliance requirements than S corporations.

To form an S corp, the following requirements have to be met: 

• Have no more than 100 shareholders
• Only individuals and certain trusts and estates can be shareholders, not corporations and partnerships
• Have only one class of stock (no preferred stocks)
• Owners must be U.S. citizens or permanent residents

Choosing the right business structure for your needs

Choosing the right business structure for your venture is a significant decision that can considerably affect its success and growth. 

To make an informed decision, you need to ponder a range of factors, such as the legal requirements, management and ownership structures, and potential tax implications of each structure. 

Factors to consider

Several factors come into play when deciding between corporations and LLCs, such as: 

• Business size
• Business objectives
• Preferred tax structure
• Advantages and disadvantages of each structure
• Funding needs 

For example, small businesses and startups may prefer the simplicity and flexibility of an LLC, while larger businesses seeking to raise capital and attract investors might opt for the more structured and formal approach of a corporation. 

Seeking expert advice 

Considering the significance of selecting the appropriate business structure, consulting with a business attorney or accountant for guidance is highly recommended. These professionals can help you navigate the legal and financial implications of each structure, ensuring you make the most informed decision. Additionally, they can help you optimize your tax planning and compliance efforts.

Why choose an LLC over a corporation?

New business owners might choose a limited liability company (LLC) over a corporation for the following reasons: 

• An LLC offers the same level of liability protection as a corporation but with a more informal management structure that suits small businesses.
• LLCs generally have less rigid management, meeting, and record keeping requirements.
• LLCs are not subject to double taxation on dividends, as some corporations are.

Why choose a corporation over an LLC?

While the ease of setup and simpler reporting can make an LLC attractive to new business owners, as your business grows, you may need to consider changing your LLC to a corporation because: 

• Corporations are able to sell stock. They can be more attractive to investors as the business grows. 
• Corporations can help your small business owners save on taxes if you decide to file for an S corp tax designation.
• Corporations can continue to exist even when stocks change hands.

Transitioning between business structures

As your business evolves and expands, you might find it necessary to switch between business structures in certain cases. For example, you might decide to convert an LLC into a corporation to attract investors or take advantage of certain tax benefits. Conversely, you may choose to convert a corporation into an LLC to simplify your business structure and reduce legal requirements.

Regardless of the reason for the transition, careful planning and expert guidance are crucial for a smooth and successful change in business structures while complying with all relevant state and federal regulations.

Converting an LLC to a corporation

Converting an LLC to a corporation involves several steps, including:

1. Filing the necessary documents with the state
2. Meeting legal requirements, which may include obtaining consent from the LLC members
3. Forming a new corporation
4. Dissolving the LLC if desired

Understand the tax implications and other considerations associated with converting your business transactions from an LLC to a corporation, as this process can impact your business's financial and legal status.

Converting a corporation to an LLC

If you decide to convert a corporation to an LLC, the process typically involves dissolving the corporation and forming a new LLC. In some cases, a direct conversion may be possible without dissolving the corporation, depending on the state's regulations.

Similar to converting an LLC to a corporation, consulting a business attorney or accountant is crucial when transitioning a corporation to an LLC. They can help you understand the potential tax implications, legal requirements, and other considerations associated with the conversion process.

Choose the entity that's right for you

By understanding the key differences between LLCs and corporations, carefully weighing their respective advantages and disadvantages, and seeking expert advice, you can confidently select the most suitable structure for your business's unique needs. And, as your business evolves, remember that transitioning between structures is possible with proper planning and guidance.

FAQs

Who pays more taxes, an LLC or a corporation?

It depends on the entity's earnings and state tax rates. Some states also require corporations to pay a minimum franchise tax.

Am I required to have an LLC or corporation to hire employees?

Actually, no. You can be a sole proprietor and hire employees. But this is a risky proposition because you have no liability protection. Let’s say an employee gets injured and files a lawsuit against your business. With a sole proprietorship, your personal assets could be on the line to settle the lawsuit. 

Which is more expensive to set up: An LLC or a corporation?

It’s generally more expensive to set up a corporation than an LLC. The filing fees for articles of incorporation vary by state but range between $45 to $315. Sometimes, the filing fee is tied to the number of stocks. 

Forming a corporation also requires additional paperwork, like creating bylaws and appointing a board of directors. The additional legal fee can be another $260 per hour. 

Why do investors not like LLCs?

Most investors seek some form of ownership over the company in return for their investment. As LLCs can't give them stocks, investors prefer corporations. If the investor becomes an LLC member in return for their investment, they may be taxed on the LLC's profits.

Jane Haskins, Esq., contributed to this article.