LLCs and corporations are two of the most common types of business entities. Although they share many similarities, there are also important differences that can make either LLC or inc. a better choice for a small business owner.
"LLC" stands for "limited liability company," while the abbreviation "inc." at the end of a company name means the business is a corporation. Both LLC and inc. offer personal liability protection for their owners. They may also provide tax advantages, lend legitimacy to a business, and position it for growth.
LLCs and corporations differ in their ownership structure, management structure, and recordkeeping requirements, however. And LLCs are often treated differently than corporations for tax purposes.
LLC business structure
An LLC is a separate legal entity from its LLC owners. This legal separation means that LLC owners don't have personal liability for business debts. If there's a lawsuit or claim against the business, the owners may lose the money they've invested in the business, but their personal assets are protected.
An LLC is created by filing articles of organization with the state. An LLC is governed by state LLC laws and the LLC's operating agreement, a contract between the owners that specifies their rights and responsibilities and the way the LLC will be run.
Corporation business structure
A corporation provides the same limited liability protection as an LLC for its owners, who are called "shareholders." A corporation operates according to its corporate bylaws.
A corporation is formed by filing articles of incorporation with the state. People are often confused by the terms "corporation," "C corporation," and "S corporation." A corporation is a type of legal entity. S corporations and C corporations are not business entities—they are federal income tax classifications used by corporations and LLCs. We'll discuss this further in the section on taxes below.
LLC vs. inc.
The difference between LLC and inc. can seem small, but if you're a small business owner, it's important to choose the right legal entity. The sections below discuss the differences between the way the two types of businesses operate.
LLC vs. inc. ownership structure
Corporations issue shares of stock to their owners, who are called shareholders. Corporate shares are easy to transfer from one owner to another, and therefore a corporation can be a good choice for a business that anticipates having outside investors or making a public stock offering.
The owners of an LLC are called "members." Instead of shares, each member owns a designated percentage of the company, sometimes called a "membership interest."
Membership in an LLC may be more difficult to transfer than shares in a corporation. An LLC's operating agreement will typically specify whether and how membership interests can be transferred.
In some states, if a member leaves an LLC and the operating agreement does not specify otherwise, the LLC must be dissolved.
LLC vs. incorporated management structure
Corporations have been around for a long time, and they have a fairly standard and rigid management structure. Corporations must have a board of directors that sets policies and oversees the business.
A corporation's officers manage its day-to-day affairs. In a small corporation, one person may wear several hats—being a shareholder as well as an officer and director. In larger corporations, shareholders are less likely to be involved in running the business. Corporations typically hold annual shareholder meetings of the corporate owners, however. The rights and responsibilities of the directors, officers, and shareholders are spelled out in the corporation's bylaws.
LLCs are designed to have a more flexible management structure. An LLC can be managed by its members or by a group of managers. Typically, in a member-managed LLC, the owners are heavily involved in running the business, while a manager-managed LLC may have a larger number of owners and/or owners who are passive, outside investors.
Reporting and recordkeeping: corporation vs. LLC
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. In general, corporations are subject to more regulations and requirements than LLCs.
Corporations are usually required to hold an annual shareholder meeting, and they must give notice of that 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 corporations, 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 recordkeeping 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.
Limited liability company taxes
The Internal Revenue Code doesn't have a tax classification for limited liability companies. Instead, the IRS treats an LLC as either a sole proprietorship, a partnership, an S corp, or a C corp for federal income tax purposes.
By default, a single-member LLC is taxed like a sole proprietorship or "disregarded entity," while a multimember LLC is taxed like a partnership. Owners are considered self-employed, and they report business income and expenses on their personal tax returns. They pay personal income tax on their share of business profits, and they also pay their own Medicare and Social Security taxes, otherwise known as “self-employment taxes."
An LLC can also choose to be taxed as if it were a corporation by filing a form with the IRS electing either S corporation or C corporation status. This flexibility is unique to LLCs. If an LLC is taxed as a corporation, its owners can be company employees, pay themselves a reasonable salary, and potentially save money on self-employment taxes. If your LLC is earning steady profits, talk to an experienced tax professional about whether you might benefit from corporate taxation.
Corporate income tax
Corporations can be taxed in one of two ways. By default, they are taxed as C corporations. A C corp is a separate taxable entity that pays corporate income tax on corporate profits. Shareholders then pay personal income tax on any dividends they receive. Since the dividend amounts are taxed at both the corporate and personal level, this is sometimes referred to as "double taxation."
Some corporations can avoid double taxation by choosing to be taxed as S corporations. An S corp is a pass-through tax entity that doesn't pay corporate income tax. Instead, the corporation's profits flow to the corporate shareholders' personal tax returns, and each S corp shareholder pays personal income tax on his or her share of the profits.
To be taxed as an s corp, a business must meet certain requirements:
- Be a domestic business entity
- Have 100 or fewer shareholders
- Have only individuals and certain trusts and estates as shareholders
- Not have nonresident aliens, partnerships, or corporations as shareholders
- Have only one class of stock
A corporation elects S corp taxation by filing a form with the IRS. If a corporation doesn't meet the requirements to be taxed as an S corp, it must be taxed as a C corp.
Operating agreement vs. corporate bylaws
One LLC vs. corporation difference is the type of document governing business operations. For an LLC, the document is called an operating agreement, while a corporation has bylaws. These documents serve similar purposes, but there are some important differences.
An LLC's operating agreement is a contract between LLC members. It typically includes such things as member contributions, management responsibilities, accounting principles, procedures for new or departing members, and dissolution procedures. Most states give LLCs a great deal of flexibility in what they include in an operating agreement.
Corporate bylaws dictate the operations of the board of directors. They typically include procedures for giving notice of shareholder meetings, accounting principles, the number and terms of directors, and more. Many states' laws require the bylaws to include certain information. Although the initial board of directors signs the bylaws, the bylaws are not a contract between the directors.
Bylaws and operating agreements are internal documents. They are not filed with a state agency and are not public records.
The exact contents and level of detail of bylaws and operating agreements will vary depending on the company. Get legal advice to make sure your company's governing documents are complete and tailored to the way you run your business.
What are the benefits of an LLC or inc.?
Both LLC and inc. provide legal liability protection to their owners. This limited liability protection means that LLC members and corporate owners aren't personally liable for business debts. In addition to liability protection, LLCs and corporations each offer unique benefits.
Benefits of an LLC include:
- Flexible management structure well-suited to small businesses
- Ability to be taxed as a disregarded entity, partnership, or corporation
- Typically fewer recordkeeping requirements than a corporation
Benefits of a corporation include:
- Standardized management structure
- Some tax flexibility. Some corporations can avoid double taxation by electing s corporation taxation.
- More appealing than an LLC to outside investors because corporate shares are easier to transfer than LLC membership interests.
There's no one-size-fits-all answer to the LLC vs. corporation question. Get legal and tax advice before you decide which business type is right for your startup.
What makes a company incorporated?
A company becomes incorporated by filing articles of incorporation with the state agency that handles business filings. The state then issues a certificate confirming that the corporation officially exists.
What type of company is inc.?
The abbreviation "inc." at the end of a business entity name means that the business is a corporation. "Inc." stands for “incorporated."
Why change from LLC to inc.?
It's possible to convert an LLC to a corporation by filing paperwork with the state where you formed the LLC. Business growth and the need for outside investors is a common reason for making the switch. Investors tend to prefer corporations over LLCs because corporations have a more standardized structure and well-developed body of law, and the shares of a corporation are easier to issue and transfer to investors than the ownership interest in an LLC.
Why would you choose an LLC over a corporation?
New business owners might choose a limited liability company (LLC) over a corporation because 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 recordkeeping requirements. And they are not subject to double taxation on dividends, as some corporations are.
Is inc. better than ltd.?
While “inc." signifies a corporation, “Ltd." can have a couple of different meanings. In some states such as Ohio, “Ltd." is an acceptable abbreviation for an LLC. “Ltd." is also a type of limited liability business entity in the United Kingdom. “Ltd." is not an abbreviation for a corporation.
Can LLC and Inc. have the same name?
Under most states' laws, there cannot be two businesses registered with the state under the same name. The fact that one name ends in “LLC" and another ends in “inc." does not make them different. An LLC in one state, however, could have the same name as a corporation in another state.
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