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Starting a company is a serious decision and a lot will depend upon the type of entity you pick. Many entrepreneurs-to-be find themselves stuck selecting between an Inc. (corporation) and an LLC.
These two business forms have many features in common yet are still quite different. How do Inc. and LLC stack up? What are the peculiarities of each entity type? Which one is the best for your enterprise? Let’s figure that out.
A corporation is a legal entity established by one person or several individuals sharing a single entrepreneurial goal. Corporation owners are called shareholders since they hold a share of a company’s equity.
A unique feature of corporations is that they can be set up for gaining profit or as not-for-profit entities:
For-profit corporations are aimed at earning income, which is further split between the stockholders pro rata with their contributions;
Not-for-profit corporations are created to serve some social purposes. They are charitable, educational, religious, or scientific organizations. Their revenues are further used by companies.
Types Of Corporations
Corporations are divided into three major types distinguished by structure, income distribution, and taxation principles.
C-Corps: It’s a standard type of entity. It stands for bigger companies owned by multiple persons. C-Corps pay corporate income taxes while their owners are taxed at an individual level;
S-Corps: Created in the same way as C-Corps, S-Corporations are limited in a number of shareholders (up to 100). Company incomes are taxed under individual tax reports of their shareholders;
Nonprofits: To set up a charity fund or any other such organization, you need to form a corporation registered as a nonprofit. By getting revenues via donations and retaining them for company operations, nonprofits are exempt from taxes.
Corporation Pluses And Minuses
Efficient company management
Non-restricted ownership transfer
Great investment potential
Limited liability: Responsible only for their equity share, stockholders are securely protected from creditor claims toward their personal assets;
Efficient company management: Corporations are run by a board of directors who hire professional managers, thus, keeping shareholders away from ongoing business management;
Non-restricted ownership transfer: Corporate ownerships can be easily transferred by simply selling the shares;
Great investment potential: Corporations can attract investors by selling shares and issuing stock.
Dual taxation: While a company should pay taxes on a corporate income, shareholders will pay levies on the dividends distributed to them;
Formal routines: Corporations entail quite a number of formalities to follow both at the incorporation and at the maintenance stage.
What Is an LLC?
A limited liability company is just what it sounds like. It’s an entity organized to legally separate a company from its owners and protect personal owner property by ensuring a liability shield.
Unlike other business types, LLCs are relatively new to the business world. At the same time, they make a great alternative to those entity types by smartly combining characteristics of each of them.
Types Of LLC
LLCs could be formed by a single owner or multiple co-owners to maintain different business plans and scenarios. Along with single-member and multi-member LLCs, other types include:
Domestic LLCs: LLCs are governed by state laws. So, LLCs that are registered and run their business in the same state are called domestic LLCs;
Foreign LLCs: If you decide to expand your entrepreneurial activity to other states, you’ll have to get a foreign LLC qualification to make your business legitimate in all states outside your domicile;
Professional LLCs: This type of LLC requires that its owner has a professional license. A PLLC doesn’t protect a license holder from liability if professional negligence or malpractice occurs;
Series LLCs: Allowed in 17 states, it’s an LLC structure that hosts several business groups as a parent company. Those are independent entities that share the liability shield of a parent LLC.
LLC Pluses And Minuses
Limited ownership transfer
Restricted fund-raising sources
Annual LLC tax
Liability protection: Being separated from their owners at a legal level, LLCs keep their members free from company liabilities. So they will not be held responsible for the business debts;
Tax options: LLCs make use of pass-through taxation by default. Yet, they have an option to choose a corporate tax status to catch up with income growth;
Simplicity: Though requiring state registrations, LLCs are a breeze to organize and quite easy to maintain. There are only a few requirements and regulations you’ll have to observe;
Flexible management: Company owners can either delegate operational control to hired managers or govern the company by themselves or along with third-party directors.
Limited ownership transfer: LLCs don’t issue bonds and stock, so transferring ownership rights is a tricky task. Some jurisdictions even require an LLC to be dissolved if one of its owners passes away;
Restricted fund-raising sources: LLCs can’t raise money and engage investors by selling shares. The only source of maintenance funds for them is business credits and loans;
Annual LLC tax: Some states have a franchise tax or so-called LLC tax to be paid on an annual basis. The rates vary from $100 to $800.
Inc. vs LLC: Similarities
Since an LLC structure has adopted some corporate features to become more welcoming and engaging for private entrepreneurs and small business owners, LLCs and corporations do have some similarities.
Both LLC and Inc. require state registration to become legally existent. To establish each of these entities you need to:
Choose a name for your future company and check if it’s available;
Appoint a registered agent to handle your legal mail;
File your formation or incorporation documents with a state office;
Execute company bylaws;
Obtain an EIN;
Open a business bank account;
Register the necessary business licenses.
Liability protection is one of the biggest draws of both corporations and LLCs. It limits the owners’ personal responsibility against the company’s debts and obligations.
These entities keep members and shareholders shielded against company lawsuits and litigation. Likewise, owners’ individual funds, property, and any other assets can’t be used to settle those lawsuits.
Inc. vs LLC: Differences
While having a lot in common, LLCs and corporations are not the same. The main areas where these two entity types distinctly differ are described below.
Corporations have initially a more complex ownership structure. It relies on the issue of shares or stock and the distribution of those shares among shareholders. In other words, they buy stock.
LLCs, on the other hand, have no issued stock, and company owners or members own a percentage of the company’s equity pro rata with their contributions.
While corporations can easily raise funds via investments by simply selling stock, LLCs don’t have that opportunity. The same is true for the ownership rights transfer.
LLCs are much easier to manage than corporations. LLCs are entitled to operate the business on their own or hire a third-party manager for that purpose.
Meanwhile, corporations are to observe quite strict formalities in this concern and should stick to the following structure:
Shareholders are company owners who elect the Board of Directors to do strategic planning;
Directors should hire officers who will be responsible for ongoing operations and day-to-day management.
Though in a single-owner corporation the owner could perform all those management functions, a formal part remains the same.
In most states, LLCs just need to timely file annual reports to stay compliant with the state.
By way of contrast, corporations should hold regular shareholder and board meetings as well as record share transfers and issue reports to shareholders.
Corporations can be taxed in one of the following ways:
As C-Corps (it’s a default method) that are exposed to dual taxation. A company should pay compulsory charges over the corporate income and shareholders get their dividends taxed;
As S-Corps that pay income taxes only at a shareholder level. Company co-owners pay levies only over their part of the company revenues.
LLCs are even more flexible in taxation. Taxed as pass-through entities by default and free from paying corporate income taxes, LLCs are entitled to choose corporate tax status to catch up with business growth.
Both LLCs and corporations have their benefits and downsides. And there is no one-size-fits-all choice when considering one of those entities for your future business.
Distinguished by simple management and flexible taxation, LLCs perfectly match smaller private businesses.
Corporations, at the same time, are a better choice for enterprises with ambitious growth plans that will need third-party investments at some point.
How much does it cost to set up an Inc. vs LLC?
Many beginner entrepreneurs think corporations are much more expensive than LLCs. However, in most states, filing rates for LLCs and corporations are the same. They might vary from $50 up to $500.
Some jurisdictions might have added government fees for corporations that will bump the cost by $50 to $250. Besides, if you hire an attorney to help you, get ready to pay up to $1000 for the service while a specialized company will provide assistance at about $150 on average.
Which entity type is better from the taxation standpoint?
There is no single right answer to this question since each entity type has something to offer to a certain business situation. So, your right answer will depend on the income level of your business and your business plans and perspectives. You’d better consult an accountant on that point.
Should I choose an LLC or Inc. for an online business?
A registered business form is a better choice for an online business than a disregarded entity, that’s for sure. If you’d ask a lawyer or business consultant, most of them will recommend setting up an LLC and then applying for an S-Corp tax status to optimize taxes for growing profits.
When is it time to incorporate my business?
If your business is successful and experiences growth, it’s time to think about creating a legal structure to maintain it and protect yourself from the burden of business liabilities. Incorporated companies enjoy better credibility, tax benefits, and investment opportunities.