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Despite where you are in the business formation process, you likely know “Inc.” stands for “incorporated” and “LLC” stands for “limited liability company.”
But you likely have questions about “Inc.” vs. “LLC.” If you’re starting your own company, you may be wondering what’s the difference between LLC vs. Inc. and what’s best for you. Both an “Inc.” (a.k.a., a corporation) and an LLC offer personal liability protection for you, but they have key differences that affect ownership, management, and taxation.
We address common LLC vs. Inc. FAQs below. And once you’re ready to form one business type, join the more than 300,000 businesses that have relied on us to form their company.
Corporations and LLCs both provide some benefits for their owners. For many, the primary reason for entering into an LLC or a corporation — as opposed to an unincorporated entity like a sole proprietorship — is to protect the business owner from personal liability. Those wishing to sue or otherwise collect from your company are usually limited to coming after the funds of the corporation or LLC, not the owners’ personal assets (personal savings, house, car, etc.).
Both LLCs and corporations are official state-recognized legal business entities. In addition to the liability protection that affords, having that “LLC” or “Inc.” in your business name makes you look legit to potential customers.
Think about it. Would you feel better doing business with Joe Shmoe, Schmoe Electric, or Schmoe Electric, Inc.?
Corporations are not only treated as separate legal entities, but also tax entities. The corporation itself is federally taxed on any profits it makes. But then, the individual owners of the corporation (called “shareholders”) are also taxed on the profits they receive from their share of the company.
That means the profits are taxed twice. The IRS takes taxes from the corporation when it makes a profit. When the remaining profits are distributed to the shareholders, the profits are taxed a second time on the shareholders’ individual tax returns. This is called “double taxation.”
Business structures like sole proprietorships and general partnerships don’t have this problem. The owners just report any profits they’ve made from the business on their personal tax returns. The business isn’t taxed separately. This is called “pass-through taxation.”
By default, an LLC has the pass-through taxation of a sole proprietorship or general partnership.
That’s why many people consider LLCs to be the best of both worlds: They combine the liability protection of a corporation with the tax savings of a sole proprietorship.
But that’s not all. LLCs also have flexibility in the way they’re taxed. In certain cases, an LLC could save more by being taxed as a C corporation (the default form of corporation) or an S corporation (more on that later).
Another drawback in running a corporation is the rigidity of the corporate structure. By law, corporations have strict management guidelines they must follow.
A corporation must appoint a Board of Directors to make decisions on behalf of the company and appoint corporate officers to handle its daily operations. While it’s permissible for one person to fulfill all those roles in a small corporation, they still must follow the government’s guidelines to the letter.
With an LLC, you can sidestep many of those formalities. As long as you stay within the law, you can lay out the rules for how your LLC will be governed in an operating agreement. You can have any single owner (called a “member” in an LLC) or group of owners manage the LLC, making for a more centralized management structure.
The two common management structures for LLCs are member-managed and manager-managed. In a member-managed LLC, the members are heavily involved in running the business and make decisions for the company on a daily basis.
In a manager-managed LLC, the members either appoint one or more of their members to serve as manager(s) or hire an outside person to manage the LLC. This is sometimes the case if the members are primarily investors and want to have someone else handle day-to-day operations.
In either management style, it’s important to spell out what kinds of decisions each member or manager is authorized to make. For example, you might want major decisions to require unanimous approval from the members.
A corporation’s ownership is determined by shares issued to shareholders. This is a rigid structure in which each shareholder’s percentage of ownership is directly reflected by the number of shares they own.
An LLC treats its ownership as a percentage owned by each member. The percentage of the business owned is called the “membership interest.” The difference with a corporation is that LLC members are free to determine ownership percentages among members as they wish, regardless of how much capital each member contributed. They can specify this in the operating agreement.
Likewise, members can also use the operating agreement to spell out how they want company profits to be distributed among themselves. The percentage of profits each member receives doesn’t necessarily have to reflect the members’ ownership percentages.
As long as all the members agree on how they want ownership and profits divided, they can formalize it in the operating agreement. Once it’s signed by all members, it becomes legally binding.
Legal requirements for reporting and bookkeeping vary from state to state, but, in general, LLCs have fewer requirements for both than corporations. For example, corporations are required to hold (and give notice of) annual shareholder meetings. Also, corporate minute books must be maintained to track certain actions. And a publicly traded corporation (one that sells stock to the public) has still more reporting requirements.
LLCs have fewer requirements like this and less paperwork in general. Many states require both corporations and LLCs to file annual or biennial reports to update the state government on basic information about the business, but these usually aren’t overly complicated.
LLCs aren’t recognized outside the U.S. That makes doing business in other countries difficult. Corporations, though, are internationally recognized.
Raising capital is important for a business. A corporation’s ability to sell shares makes it easier to attract investors. An LLC can’t issue shares, and selling percentages of an LLC can be complicated.
Investors are more likely to be attracted to investing in the more familiar form of corporations. The corporate structure also allows you to do an IPO, something not possible with an LLC.
We can talk about the general differences between “Inc.” and “LLC” here, but an article like this can only go so far when it comes to tax information. What’s considered a plus or minus will depend largely on your particular business’s circumstances. A tax professional can best advise you as to which business entity would benefit you most.
For example, if you decide that an LLC suits you best, you still have a decision to make as to how you want to be taxed. Although the default method is to be taxed as a sole proprietorship and avoid double taxation, you also have the option to be taxed as a C corporation, which can sometimes be advantageous to larger LLCs (this is another great question for your accountant). Another option, being taxed as an S corporation, could potentially save you money in self-employment taxes. We’ll address that below.
Under the right conditions, an LLC or corporation can file to be taxed as an S corporation (S corp). An S corp isn’t a separate kind of business entity, but a tax election status. Often it’s a way for C corporations to avoid double taxation because it allows them to be taxed as a pass-through entity.
Sometimes LLCs can also benefit from filing as an S corp because it can save the members money on self-employment taxes. Usually, LLC members pay self-employment taxes (about 15.3%) on all profits they receive from the company. This is double what they’d pay when working for another business because their employer would pay half of them.
Being an S corp allows the owners to pay themselves a salary. When that happens, they can receive income from the business in two ways, as a salary and as their share of the profits. But whereas before they had to pay self-employment taxes on all the profits they received, now they only have to pay self-employment taxes on their salary. Their remaining share of profits isn’t subject to self-employment taxes.
This savings in self-employment taxes can add up to thousands. But, the IRS expects you to pay yourself at least a “reasonable” salary so that you’ll still pay something in self-employment taxes (and thus still contribute to Social Security and Medicare).
S corps do come with some restrictions. An LLC or C corporation can be taxed as an S corp only if they fill out the right IRS forms and meet the requirements, which include having:
Because of the requirements and the potential for abusing the system by not paying oneself enough salary, the IRS scrutinizes S corps more closely. So, you may have a greater risk of being audited.
Again, tax issues are complex, so seek advice from a tax professional.
When you’ve decided whether you want “LLC” or “Inc.” at the end of your new business’s name, our experts are standing by to help. They can walk you through the process of forming an LLC, a corporation, or even an S corporation.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.