LLC vs. Incorporation: Which Should I Choose? (2024)

The decision to form either a limited liability company (LLC) or a corporation depends on the type of business that an individual is creating, the possible tax consequences of forming the entity, and other considerations. The primary difference between an LLC and a corporation is that an LLC is owned by one or more members while a corporation is owned by shareholders.

Both types of entities have the significant legal advantage of helping to protect assets from creditors and providing an extra layer of protection against legal liability. In general, the creation and management of an LLC are much easier and more flexible than that of a corporation. Still, there are advantages and disadvantages to both types of business structures.

Key Takeaways

  • The creation of a limited liability company (LLC) is a much simpler process than creating a corporation and usually requires less paperwork.
  • LLCs are created under state law, so the process of forming one depends on the state where it is being filed. Once an LLC is formed, it is good practice to set out the roles and responsibilities of the members by creating an operating agreement to define these roles.
  • The Internal Revenue Service (IRS) does not view an LLC as a separate vehicle for tax purposes, which allows for greater flexibility. Members can choose how they are taxed. They can be treated as a sole proprietorship, a partnership, or a corporation.
  • Two types of corporations can be formed: an S corporation and a C corporation. An S corporation is a pass-through entity, like an LLC, where the owners are taxed on profits and losses of the corporation. A C corporation is taxed at the corporate level, separately from its owners, through a corporate income tax.
  • Corporations offer more flexibility when it comes to their excess profits. Whereas all income in an LLC flows through to the members, an S corporation is allowed to pass income and losses to its shareholders.

Advantages of an LLC

Ease of Forming

Creating a limited liability company (LLC) is a much simpler process than creating a corporation and generally takes less paperwork. LLCs are under the jurisdiction of state law, so the process of forming an LLC depends on the state where it is being filed.

Most states require filing articles of organization with the secretary of state, and some states allow for them to be filled out online. A few states require an additional step of filing a public notice, often in local newspapers. Once these steps are completed, the LLC is officially formed. There are lots of LLC filing services that can help, too.

Once an LLC is formed, it’s good business practice to set out the roles and responsibilities of the members. The members are individuals with an ownership interest in the LLC. Most LLCs use an operating agreement to define these roles.

Drafting an operating agreement is not necessary for an LLC to be valid, but it is a prudent course of action. If no operating agreement is created, then an LLC is governed by the default rules contained in state statutes.

The operating agreement sets forth the rights and responsibilities of the members. It can define the business relationship and deal with issues of capital structure, allocation of profits and losses, provisions for the buyout of a member, provisions in case of the death of a member, and other important business considerations.

Tax Flexibility

The Internal Revenue Service (IRS) does not view an LLC as a separate vehicle for tax purposes, which allows for greater flexibility. Members can choose how they are taxed. They can be treated as a sole proprietorship, a partnership, or a corporation. The most common tax option of an LLC is taxation similar to a sole proprietorship.

A member has to pay taxes themselves on the profits of the LLC as opposed to the LLC paying the taxes. The profits and losses of an LLC are passed through the business to the owner. The owner then has to report the profits or losses on their own personal tax returns. The LLC itself does not pay any corporate tax. This method avoids double taxation, which is a drawback of corporations.

Disadvantages of an LLC

Although an LLC does come with plenty of advantages, there are some disadvantages to consider. LLC members also have to pay a self-employment tax, which includes a 12.4% tax for Social Security and a 2.9% tax for Medicare.

There are other drawbacks to an LLC as well. The purpose of an LLC is to protect its members from any liability. If the company fails to meet its obligations, then creditors can target only the LLC, not the assets of the members. However, there are certain situations in which an LLC can be automatically dissolved, leaving members open to risk.

Automatic dissolution can be triggered if an LLC fails to report its filings on time; a death or withdrawal of any member occurs unless succession provisions are outlined in the operating agreement; a change in the structure of the LLC, such as a merger; and any terms with expiration dates. In these situations, an LLC can continue doing business, but the liability structure of the members may alter, defeating the initial purpose of creating the LLC.

Before the passing of the Tax Cuts and Jobs Act in 2017, an LLC treated as a partnership for tax purposes could automatically be terminated due to tax reasons as well. The automatic termination was triggered if there was a transfer of 50% or more of an LLC’s total interest or profits within 12 months. This rule no longer applies from tax year 2018 and beyond.

Another major disadvantage is the differences among states in the statutes that govern LLCs. This can lead to uncertainty for LLCs that operate in multiple states. The differences in rules and regulations can result in additional paperwork and inconsistent treatment across different jurisdictions.

Advantages of a Corporation

Despite the ease of administration of an LLC, there are significant advantages to using a corporate legal structure. Two types of corporations can be formed: an S corporation and a C corporation. An S corporation is a pass-through entity, like an LLC, where the owners are taxed on profits and losses of the corporation.

A C corporation is taxed at the corporate level, separately from its owners, through a corporate income tax. C corporations are the most common type of corporation.

C corporations have the advantage of allowing profits to remain with the corporation and paying them out as dividends to shareholders. Also, for businesses that eventually seek to issue stock, a C corporation can easily issue shares to raise capital for further expansion of the business.

Corporations offer more flexibility when it comes to their excess profits. Whereas all income in an LLC flows through to the members, an S corporation is allowed to pass income and losses to its shareholders, who report taxes on an individual tax return at ordinary levels.

As such, an S corporation does not have to pay a corporate tax, thereby saving money, as corporate taxes are higher than ordinary taxes. Shareholders can also receive tax-free dividends if certain regulations are met.

Disadvantages of a Corporation

There are significant disadvantages to creating a corporation regarding the amount of complexity involved. It requires a great deal more paperwork, meeting many more guidelines, electing a board of directors, adopting bylaws, having annual meetings, and creating formal financial statements. They generally have more burdensome record-keeping requirements than LLCs.

There is also the issue of double taxation for corporations. This refers to taxes being paid twice on the same income. This is because corporations are considered separate legal entities from their shareholders. Thus, corporations pay taxes on their earnings, while their shareholders also pay taxes on any dividends that they receive from the corporation.

Am I Required to Have a Limited Liability Company (LLC) or a Corporation to Hire Employees?

No. You can hire employees or contractors as a sole proprietorship, although you may expose yourself to greater risk. A limited liability company (LLC) or a corporation protects your personal assets by creating a structure for your business separate from your personal finances.

Which Is More Expensive to Set Up: An LLC or a Corporation?

Fees for incorporating or creating an LLC vary from state to state. Forming an S corporation can range from $100 to $250 for only the state incorporation fees, not including lawyer fees. An LLC can range from $50 to $500, depending on the state.

Does an LLC Require More Than One Member?

No. An LLC only limits liability; it doesn’t establish anything about the structure of the business. A single-person business can be an LLC.

The Bottom Line

Though similar in many ways, LLCs and corporations have quite a few distinctions that bring both advantages and disadvantages to each. As an individual starting their own business, it’s important to understand all of the nuances involved and choose the right structure for your company.

LLC vs. Incorporation: Which Should I Choose? (2024)

FAQs

Should I choose LLC or corporation? ›

If your business is small and you want to be able to choose your business partners, you may appreciate these LLC restrictions. If, however, you plan to seek outside investors or provide company shares to employees, then you'll need a corporation's easy share transferability and eternal life.

Is it better to go from an LLC to a corporation? ›

“If your company is exhibiting significant growth, converting from an LLC to a corporation will give you the flexibility to allocate some profits to qualify for a lower income-tax bracket," says Paul Sundin, a CPA and tax strategist for Emparion.

Why LLC is the best option? ›

LLCs are a good combination of protection with flexibility and tax benefits. It provides an array of taxation alternatives while shielding individual members from personal liability.

What is the benefit of INC vs LLC? ›

Both types of entities have the significant legal advantage of helping to protect assets from creditors and providing an extra layer of protection against legal liability. In general, the creation and management of an LLC are much easier and more flexible than that of a corporation.

Who would a LLC be best for? ›

Who Should Form an LLC? Any person starting a business, or currently running a business as a sole proprietor, should consider forming an LLC. This is especially true if you're concerned with limiting your personal legal liability as much as possible. LLCs can be used to own and run almost any type of business.

Why is as corp better than LLC? ›

S corporations may have preferable self-employment taxes compared to the LLC because the owner can be treated as an employee and paid a reasonable salary. FICA taxes are withheld and paid on that amount.

Do LLCs pay more taxes than corporations? ›

Who pays more taxes, an LLC or S Corp? Typically, an LLC taxed as a sole proprietorship pays more taxes and S Corp tax status means paying less in taxes. By default, an LLC pays taxes as a sole proprietorship, which includes self-employment tax on your total profits.

What happens when an LLC converts to a corporation? ›

In a statutory conversion, the LLC's assets and liabilities automatically transfer into a corporation. There's no need to form a new corporation and dissolve the LLC.

What is the biggest benefit of an LLC? ›

Limited personal liability

And if your business partner or employee is accused of negligence, your personal assets might be at risk. An LLC limits this personal liability because an LLC is legally separate from its owners.

Why you should put everything in an LLC? ›

The big reason LLCs have gotten incredibly popular is because of their looser structure than traditional corporations and “pass-through” taxation. LLCs are more favorable from a tax standpoint, because the LLC doesn't pay taxes, unlike a corporation. All profit and taxes “pass-through” directly to the owners.

Why would someone use an LLC instead of as corporation? ›

You may prefer an LLC if you: want a high degree of management flexibility in running your company. want to allocate profits and losses based upon criteria other than ownership percentage. prefer to avoid the state-mandated requirements imposed on corporations, such as annual meetings.

What happens if you start an LLC and do nothing? ›

Simply put, yes, you can have an LLC with no income, but that still has expenses. An LLC with no income but deductible expenses can offset future income through a net operating loss deduction. However, the IRS will still regard this as business activity, so it must be reported yearly.

Why change from LLC to Inc? ›

An LLC is considered a pass-through entity for income tax purposes, while a corporation is not. Therefore, LLC owners may want to convert to a corporation to take advantage of lower corporate tax rates. One of the key benefits of converting from an LLC to a corporation is the ability to raise capital.

Should a startup be an LLC or Inc.? ›

The general consensus is that start-ups seeking venture capital should incorporate as C-Corporations, not LLCs. Interestingly, an LLC is a highly customizable entity through which a company could set up structures similar to a C-Corp.

Why do so many businesses choose LLC? ›

Properly structured, LLCs provide the benefits of limited liability protection, operational flexibility, and pass through taxation without the restrictions generally applied to S Corporations and limited liability partnerships.

Why is LLC better than C Corp? ›

LLCs have more flexible tax structure options than corporations. An LLC by default is a pass-through entity, meaning it's taxed like a sole proprietorship if it has one member, or a partnership if it has more than one member.

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