LLC and INC. These letters stand for two ways to designate your business as an entity separate from yourself. “LLC” stands for “Limited Liability Company”, and “Inc.” or “corp.” refers to a corporation. Both designations protect business owners from financial liability, separating personal assets from business assets. But if you’re thinking of either forming an LLC or incorporating your business, what you really need to know is how these designations differ. We’ve outlined the three major ways that they are different: their requirements for ownership, their management structure, and how they are taxed.
Limited Liability Company
- Owners of an LLC are called members. Each member owns a designated percentage of the company, which is decided upon during the LLC formation process and written into the operating agreement. This step is especially important if one member owns a larger or smaller percentage of the company than the percentage of their initial investment.
- Membership in an LLC may be difficult to transfer, meaning you can’t easily back out of owning a part of the business. This depends on what has been written into the operating agreement. In some states if the operating agreement does not specify membership annulment, the company must be dissolved if a member wishes to leave the LLC.
- LLCs allow for flexible management. They can be managed by its members, or by an outside group of managers, which is often overseen by investors.
- Many business owners prefer the tax structure of LLCs, which allows them to report business income as personal income on tax returns, using self-employment tax forms. As we will see, this is in contrast to the way that owners of corporations are “double taxed.”
- In a publicly traded corporation, “owners” are people who invest in the company by buying stock, or shares, of the company. Investors, and owners, are referred to as shareholders. It is up to the corporation to determine how many shareholders are invested in the business. Some corporations, after meeting national regulatory requirements, can opt to have publicly traded shares. This is an opportunity to increase their capital by gaining investors from the general public. For example, Google is a publicly traded corporation, and they have nearly 15,000,000 shareholders invested in their company.
- Corporate shares are easily transferred from one owner to another, which makes incorporating a good choice for a company that anticipates having outside investors.
- Owning a share in a publicly traded corporation does not grant full rights. Many economic theorists argue that the entrepreneurs and chief executive officers are the true owners of a corporation, despite the title of ownership going to shareholders.
- Corporations require a board of directors to oversee the organization, and officers within the board to manage day-to-day affairs and operations. The rights and responsibilities of the directors, officers, and shareholders are spelled out in the corporation’s bylaws.
- Corporations are taxed as “C corporations”. They pay standard federal income tax on profits, and shareholders also pay tax on dividends received. Owners of a C corporation are essentially subject to double taxation, since they pay personal taxes on dividends as well as corporate taxes on profits.
- Corporations that have fewer than 100 shareholders can avoid double taxation by filing taxes as an “S corporation.” S corporations are known as “pass-through entities” which mean that the corporation’s net income passes straight through to the owners and shareholders. The corporation itself does not have to pay federal income tax; shareholders are taxed on the income they receive from the corporation.
Which is best for you?
There’s a lot to take on board if you’re considering forming an LLC or incorporating a business. Which one is best for you depends on your plans. Take into consideration that LLCs:
- are a newer concept.
- allow for more flexibility in management and operations.
- are only recognized nationally.
- have a standardized and rigid management structure.
- have a longer history which can offer legitimacy to your organization that is desirable for outside investors.
- are recognized internationally.
Both LLCs and corporations must follow the laws of the state where they were formed, and each state has their own rules about LLC and Inc. dues and fees, record-keeping, and reporting to the government. It’s important to consider all of your state requirements, your business plans, and future goals before deciding on which type of business entity is best for you.