Corporation vs. LLC: Which One is Right For Me?
Picking a business structure is a vital first step in legitimizing your business. There are many to choose from, but the Limited Liability Company (LLC) and the Corporation (Inc.) business structures are the most common.
When choosing a corporation vs. LLC, it is important to consider that the law treats each type of structure differently in terms of taxes, ownership, reporting, recordkeeping, and management.
Whether you choose an LLC or corporation, however, you’ll benefit from limited liability.
What is Limited Liability?
Limited liability is a form of legal protection that shields your personal assets in case your business faces a lawsuit. You’d only be liable for the amount you have invested in your business.
Without limited liability, the court could seize your house, car, or other personal assets should the plaintiff win the suit.
Fortunately, you get limited liability, whether you incorporate or form an LLC. The amount differs, though, as both types of businesses have different ownership structures.
Corporation Vs. LLC: Ownership
Ownership structure differs significantly between corporations and LLCs. Each structure serves a different purpose. Take into account what ownership stake you’d like when deciding to form an LLC or corporation.
Corporations issue shares of stock and sell them to owners — just like you’d see with public corporations on the stock market. Owners are known as shareholders.
The more shares an owner holds in a corporation, the more ownership they have.
Shares of stock are easily bought from and sold to others. Consequently, choosing to incorporate is an excellent move if you seek outside capital or consider taking your independent business public.
LLC owners are called “members”. Each member has a “membership interest” in the company, instead of holding shares.
LLC membership interest is not necessarily defined by each member’s financial investment in the business. Instead, the LLC’s operating agreement allocates membership interest. This agreement also details how members can transfer their interests to others.
Inc. Vs. LLC: Taxation
Taxation is at the forefront of most entrepreneurs’ minds when choosing between LLC or corporation.
When you incorporate, your company becomes a distinct legal entity that earns its own income. However, corporations can be taxed as either C corporations or S corporations.
By default, corporations follow C corporation taxation.
C corporations pay federal income tax on their profits. After paying these taxes, the corporation pays dividends to its shareholders. The shareholders then pay taxes on their dividends.
Thanks to the two instances of taxation, C corporations are said to experience “double taxation”.
It may sound disadvantageous, but the tax code provides corporation-specific tax deductions that corporations can use to offset their income.
With that said, corporations with 100 or fewer shareholders that meet several legal requirements can elect S corporation taxation. S corporations are “pass-through” entities for tax purposes, meaning they avoid taxes on corporate profits. The profits are only taxed once, as they are “passed through” to each shareholder’s personal tax return.
LLC taxation is much simpler than its corporate counterpart. All LLCs are pass-through entities. LLC owners can deduct business operating costs and losses on their personal returns to offset income from other sources.
That said, the LLC’s tax rate also depends on the owner’s total income. LLC owners may also have to pay self-employment tax — and in some states, a franchise tax.
Inc. Vs. LLC: Reporting and Recordkeeping
LLCs and corporations are both governed by the laws of the state in which they exist. However, when you incorporate, your recordkeeping and reporting requirements become much stricter than if you chose an LLC.
If you incorporate, you must hold annual shareholder meetings, and you must notify shareholders in advance of the meeting date.
During these meetings, someone keeps detailed notes of everything discussed in the corporate minutes. Actions and corporate changes must be voted on in Board of Directors meetings.
Many states also require corporations to file yearly reports — and they usually charge a fee with these reports.
A Corporation can be an independent business, but it can also go public to attract more investor capital. However, public corporations must ensure their accounting follows US Generally Accepted Accounting Principles (GAAP), and the International Financial Reporting Standards (IFRS) if their stock is traded in a jurisdiction that mandates it.
Given the complex accounting situation corporations face, an accounting software program such as Quickbooks that mixes advanced functionality with a straightforward interface will make financial recordkeeping a lot easier.
Lastly, states require corporations to put an entity designator — a suffix indicating the company’s entity type and limited liability status — at the end of their name. Common corporate entity designators include “Inc.” and “Ltd.”.
LLC requirements are once again more relaxed. Some states don’t require them to file any annual reports. For those that do, the reports may be less thorough than a corporation’s.
LLCs don’t have to follow GAAP in their accounting, although doing so can make it easier to convey financial information to interested parties. With the simpler accounting situation that LLCs deal with, a small business accounting software program like Freshbooks can work well.
Like with corporations, most states require LLCs to put a designator after their name — usually “LLC” or “L.L.C.”.
Inc. Vs. LLC: Management
Are you good at managing others? Do you have time to manage others? Your management skills may play a part in choosing to form an LLC or corporation — each has different management requirements.
Corporations have been around for centuries, which has allowed them to create rigid and thorough management structures. When you incorporate, you pick a Board of Directors that adopts the corporate bylaws (rules governing management) and oversees the business.
After incorporation, shareholders vote on new Board members — shareholders with more shares hold more weight in these elections.
The Board also appoints corporate officers, such as the CEO, President, and CFO. The officers handle the day-to-day of the business from the top.
Smaller corporations could see one person playing both shareholder and management roles. However, in larger corporations, shareholders aren’t usually involved in business operations.
LLCs have only been around since the late 1970s, and they were designed with flexibility for SMBs in mind. They can either be “member-managed” or “manager-managed”.
Under the former, owners participate in day-to-day business operations. Any number of members can choose to be a manager.
Members in the latter type of LLC sit out on management and instead hire managers to run the company.
Conclusion: LLC or Corporation?
Going with an LLC or corporation depends partly on your size and your business goals.
An LLC is an excellent choice if you’re an independent business, such as a sole proprietor or SMB, and you need legal protection and tax benefits. Service businesses, such as freelancers, often become LLCs rather than corporations as well. They’re as simple as you can get while bolstering your credibility and legal status.
If you’re looking to gain more capital to expand your business faster, and willing to forgo LLC flexibilities, then putting “inc.” after your business name might be a better choice. You can become a corporation even if you run an SMB. In fact, you may be able to elect S corporation status and avoid double taxation if you meet the requirements.
Ultimately, you should consult a licensed CPA or attorney before picking a business structure.