Learn the differences between these two legal structures
When starting a new business, one of the most important decisions you’ll make is choosing the type of legal structure to use. Two common options are the corporation, specifically the “C” corporation (Inc.), and the limited liability company (LLC). While both offer unique advantages and disadvantages, it’s important to understand the differences between the two before making a decision.
Note that most people who start a business never incorporate. They remain a “sole proprietor” for purposes of reporting taxes and entering into contracts. It isn’t until after a business grows large enough to run the risk of lawsuits that incorporating becomes important. Such risks may include hiring employees, causing potential damage to customer property, running the risk of causing illness or injury to customers, or defaulting on contracts.
Moreover, another important reason to incorporate is the ability to sell your business. It’s much easier to identify a business by it’s legal entity. By contrast, with a sole proprietorship, it’s difficult to sort out where personal assets ends and business begins.
Ownership and Management
One of the most significant differences between an Inc. and LLC is the ownership and management structure. A corporation is owned by shareholders, who elect a board of directors to oversee the company’s management. The board, in turn, hires officers (such as a CEO or CFO) to handle day-to-day operations.
On the other hand, an LLC is owned by its members, who are typically involved in the day-to-day management of the company. Members can either manage the LLC themselves or appoint a manager to handle operations. This means that LLCs offer more flexibility in terms of management and decision-making.
Taxation
Another significant difference between an Inc. and LLC is the way they are taxed. A corporation is taxed as a separate entity, and shareholders must pay taxes on any dividends or other distributions they receive. This is commonly referred to as “double taxation,” as the corporation is taxed on its profits, and then shareholders are taxed again on any money they receive.
In contrast, an LLC is a pass-through entity, meaning that the business itself is not taxed. Instead, profits and losses are passed through to the members, who report them on their individual tax returns. This can result in lower taxes overall, as members only pay taxes once on their share of the profits.
Liability Protection
Both corporations and LLCs offer liability protection, which means that the owners are not personally responsible for the company’s debts and obligations. However, the level of protection offered can differ between the two.
In a corporation, shareholders are generally not personally liable for the company’s debts or obligations. However, if a shareholder is also an officer or director of the company and engages in wrongful or fraudulent behavior, they may be held personally liable.
In an LLC, members are typically not personally liable for the company’s debts or obligations, even if they are actively involved in the company’s management. This makes an LLC an attractive option for small businesses that want liability protection without the formalities and costs associated with a corporation.
Formalities and Costs
Forming and maintaining a corporation involves more formalities and costs than forming an LLC. To form a corporation, you must file articles of incorporation with the state, adopt bylaws, and hold regular meetings of the board of directors and shareholders. In addition, corporations are required to file annual reports with the state and pay fees.
Forming an LLC, on the other hand, is generally simpler and less expensive. To form an LLC, you must file articles of organization with the state, but there are fewer formalities to comply with. LLCs are not required to hold regular meetings or file annual reports, although they may be subject to other requirements depending on the state.
Ownership Transfer
Transferring ownership in a corporation is generally more complex than in an LLC. In a corporation, shares of stock must be sold or transferred to transfer ownership. This requires compliance with securities laws and may involve additional fees and paperwork.
In an LLC, ownership can be transferred simply by assigning a membership interest. This can be done without the need for compliance with securities laws or other formalities.
Conclusion
Ultimately, the decision to choose between an Inc. and LLC will depend on your business’s unique needs and objectives. If you prioritize flexibility in management and taxation, and want liability protection without the administrative requirements and expenses of a corporation, then an LLC may be the ideal option for your business. On the other hand, if you plan to raise capital by selling stock or intend to take your company public, a corporation might be a more suitable choice. It’s crucial to carefully evaluate the advantages and disadvantages of each type of business structure and consult with legal and financial professionals before making a decision.
Dawn Corbett is a driven, self-motivated, elementary educator, and a molder of young minds. She has taught in public education for twenty plus years. Creating original content is something that she is passionate about and gets excited about. She knows the value of confidentiality, cooperation, and being a team player. Working as an editor and blog writer has given her a valuable opportunities to develop her own intellect and a different perspective on how to respectfully communicate with others in different styles.