While making a choice between business types, most business owners don’t know the difference between LLC and corporation. The former combines two forms of business, i.e. partnership and corporation. On the other hand, the latter means incorporated, for instance which represents and demonstrates the form of corporation, such as S-Corp or C-Corp. So, now let’s more about the difference between LLC vs Corporation – Key Differences and how to choose one for your small business ideas.
The very first and basic question that arises before the entrepreneurs when starting a new business venture is, which business type to choose? The business structure is not just a status, rather all the legal requirements and formalities, before and after the business is set up, depends on the type itself.
So, along with discovering an innovative idea for launching a business, the businessperson should also make plans for the structure, they want for their business, to make it successful. Let us take a gander to know the difference between LLC and Corporation provided to you in this article.
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One of the first decisions you will make when starting a new business is choosing an entity type. Usually, many entrepreneurs choose to form a Corporation or a Limited Liability Company (LLC). The major difference between an LLC and a corporation is that an LLC owing by one or more individuals and a corporation own by its shareholders. No matter which entity you choose, both entities let you avail of big benefits to your business. Incorporating a business allows you to establish credibility and professionalism. It also provides limited liability protection.
A Limited Liability Company or LLC is a private company, that mix-ups the features of a corporation and a partnership firm. Here, the members are owners. LLC expands to Limited Liability Company, is a privately held company, with less or minimum legal formalities. It is considered a unique form of business which combines the features of partnership and corporation, i.e. flow-through income taxation and limited liability respectively. The business form could have an unlimited number of owners. It provides legal protection for the personal property of the owners, from business debts and obligations. LLC does not have to follow lots of legal requirements, like organized meetings, maintain minutes, record resolutions taken by the company, etc.
An LLC, however, cannot issue shares to the public, so as to raise funds from the market. Further, the rules in connection with the LLC can differ from country to country, due to the absence of uniformity.
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An Incorporation indicates a business entity under the law. An Incorporation implies the legal process of forming a corporation. Generally, the acronym Inc. is included at the end of the name by the corporations which are incorporated.
Corporation is as same as an artificial person, a separate legal entity which is treated independently of its members, having its own rights and obligations, limited liability, perpetual succession, holds property in its own name. Organizations like profit, non-profit, sports club, public or private are operated around the world as corporations. As per US law, for tax purposes, a corporation can be an S-Corp or C-Corp.
The formation of a corporation requires submission of articles or certificate of incorporation, which highlights various matters such as the objective, location, number, and type of stock. The name of the corporation is classified into three parts, which are distinctive elements, descriptive elements, and a legal ending, where the distinctive element and legal ending are a must for all the corporations.
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A private company, which combines the features of a corporation and a partnership firm, is called LLC or Limited Liability Company. Inc. is an acronym for Incorporated, used as a suffix in the name of corporations, denoting a business entity registered under the law.
The owners of the LLC are just the members, whereas shareholders are the ultimate owner of an Inc.
An LLC is a private corporation, but an Inc. is a public trade corporation.
LLC offers greater flexibility than Inc., i.e. No bar on the maximum number of members in an LL C, but an S Corp. can have only 100 members.
Inc. (Corporation) is subject to stringent legal formalities and record keeping. And when it comes to LLC the legal formalities and record-keeping is more lenient.
The best feature of LLC is passing through taxation, i.e. the income of the LLC is taxable which comes in the hands of its owners after it is distributed or submitted to them. On the contrary, Inc. have to cope up with double taxation, first at the corporate level and next at the individual level, when the profit is distributed to shareholders as the dividend.
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The Annual General Meeting (AGM) must be held by an Incorporated Corporation. As against this, the holding of an AGM is not needed, for a Limited Liability Company.
The annual reports of an Inc. should be distributed to the appropriate authority within the stipulated time. Unlike LLC, wherein the filing of annual reports, with appropriate authority is not necessary.
For smaller entities, LLC is the best option to choose, because of fewer legalities and flexibility, while for large firms, Inc. is the fruitful decision for growth and profitability prospects.
In the below section, we are going to provide you with some insight on the various areas which can help you choose the one that best suits your business needs.
Now that we have explored what both entity types have in common, let’s dive deeper into what makes them different.
The difference between corporations and LLCs is the way they pay taxes. Let us examine how taxation for each business structure works.
This means that the profits of the business are “pass-through” to the owners. Profits and losses are reported on the individual tax returns for the owners and not at the business level. As a result, filing taxes is often simpler for owners of an LLC. Any losses or operating costs of the business can be subtracted on personal tax returns.
The rate at which an LLC’s tax relies on the total income of the owner, as it does when you file as a sole proprietor. Owners of an LLC also pay self-employment taxes. Some states require LLCs to pay a franchise tax. These tax issues by the state for the special rights of doing business in that state.
Franchise taxes are usually paid annually and vary from state to state. What happens if you do not pay your taxes? Failing to pay on time or at all could result in penalties and even the involuntary dissolution of your business.
Fortunately, incorporating as an LLC offers entrepreneurs with flexibility. An LLC can elect to pay tax as a Corporation or a C Corporation. While it is an uncommon choice, filing an LLC as a C-Corp tax designation does make financial sense for some businesses.
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Corporations as an individual legal entity, which can earn its own income and also responsible for paying tax on their profits, (corporate tax) and tax on dividends the entity distributes to its shareholders. This refers to as double taxation. This is a minute thing for smaller corporations where only the owners work for the corporation. Instead, owners receive tax-deductible salaries and bonuses.
While double taxation is a disadvantage for businesses choosing to file as a corporation, this additional tax responsibility can often be offset by federal deductions that are only available to corporations. For example, a corporation may deduct all its business expenses.
These can add advertising costs and operating expenses as well as certain employee fringe benefits such as medical and retirement plans. These deductions all add up to substantial savings over time for the business.
As of 2018, corporations pay a flat tax of 21% on their profits, which is lower than the top five individual tax rates. While this is largely offset by double taxation, any income the corporation chooses to retain at the end of the year will be taxed only once at the new 21% rate. This lets the owners of the corporation to save on taxes by investing some profits back into the business.
However, keep in mind if a corporation has fewer than 100 shareholders, it can file an S Corporation election. This is a tax status that lets a business be treated as a pass-through entity much like an LLC. This may be a good option for businesses who want to be taxed like an LLC, but also want some of the additional formalities a corporation provides. The S Corporation designation best allowing allow flow-through taxation (no corporate tax), but there are certain requirements to qualify as an S-Corp that may limit its utility to a business.
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If a business qualifies as an S Corporation, then the tax difference between an LLC and S Corp is a bit more different. Both an LLC and an S-Corp has flow-through taxation where they pay taxes on all the business profits via their individual tax return forms.
By adopting careful planning a small business can avoid significant employment taxes by electing to become an S-Corp. And also there can be drawbacks of an S-Corp that may deter a small business from taking this advantage. Always consult a professional before deciding on whether tax as an LLC or S Corporation.
Ownership is another important and major aspect to keep in mind when deciding between whether to form an LLC and a corporation. The structure of ownership in each entity is very unique, and each has a clear purpose which makes choosing the right entity for your business a bit easier.
A corporation can issue shares of stock and sell percentages of the business to its owners. And these shareholders can transferring and purchasing shares and more stock to own a larger percentage of the company, or selling off stock to own less. If your business is one of those who want to attract outside investors, a corporation may be the best entity for it. A corporation also exists in perpetuity separate from the owners, meaning that a corporation remains in existence even when an owner leaves or divests from the company.
A Limited Liability Company (LLC) has a special freedom or right to distribute its ownership stake to its members without regard to a member’s financial contribution to the LLC. Let us use the example where a member of the LLC may not have invested as much capital as another member.
An LLC’s operating agreement could describe that all members receive an equal share of the profits anyway. This creates additional flexibility when establishing the ownership of the business. A thing about an LLC is also owing by foreign individuals, other corporations, or any kind of trust. This may make it the right choice for businesses in certain circumstances where these factors are important.
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An LLC has a flexible management structure. The members of a group of managers manage entity and any member may act as the LLC’s manager. The LLC may also elect to have no distinction between an owner and a manager of the business. Due to its flexible nature, LLC management seems less formal which may make it an ideal entity for some entrepreneurs.
The difference between “manager-managed” and “member-managed” LLCs is that in a member-managed LLC, the owners themselves oversee running the day to day operations, while a manager-managed LLC generally has investors that sit on the sidelines and do not have any other active role in the business. A corporation’s management structure is much stricter.
A corporation or firm must have a formal structure with a Board of Directors handling the management responsibilities of generating profits for the shareholders. Corporate officers handle the day-to-day operations of the business. The shareholders are the owners of the corporation but remain separate from business decisions and daily operations of the corporation (except for approval of major corporate decisions).
However, shareholders retain the power to elect directors and individual shareholders who elect as a director or appointed as an officer. The corporate laws dictate the individual rules of any corporation.
Both corporations and LLCs fulfill maintenance and/or reporting requirements where their entity has been formed. This can keep the business in good standing and maintains the limited liability protection acquired by incorporation. While every state has its own rules and regulations that govern both corporations and LLCs, corporations generally have more annual requirements than LLCs.
Corporations need to hold an annual shareholder meeting each year. This information documented, along with any discussions, as notes called corporate minutes. A corporation needs to file a final report, too. This assist keeps the business’ information current with the Secretary of State. Any actions or changes in the business will need a corporate resolution to be voted on at a meeting with the board of directors.
LLCs, on the other hand, have fewer record-keeping requirements than their corporate counterparts. For instance, an LLC does not need to keep minutes, hold annual meetings, or have a board of directors. While some states still require LLCs to file annual reports, others do not. Check-in with your local Secretary of State to determine which needed requirements are applicable to your LLC entity.
Many new business owners always confuse when it comes to understanding the difference between legal entities and tax entities. Let us take a moment to unpack their differences.
A tax entity is how the Internal Revenue Service (IRS) sees your business. Subsequently, this reflects how your business will be taxed. Tax entity examples add C Corporations, S Corporations, and sole proprietorship. Legal entities have a choice regarding what tax entity they want to identify as. Both an LLC and a corporation can file an S-Corp election and choose to pay tax as an S Corporation, even though they are still two different legal entities.
Well, LLCs have more options when it comes to choosing a tax identity than corporations. However, both legal and tax entities offer benefits with a CPA or attorney for the ins and outs of your business.
Both LLCs and corporations provide benefits to its owners when it comes to legal protections, although there are differences between the two. And how the court system sees them.
Corporations have been in existence since the start of U.S. history. Because of this, a corporation as an entity has matured and developed to the point where the laws have become uniform. United States courts have centuries of law history cases to help resolve disputes and issues related to corporations. This creates significant legal stability for corporations.
Limited Liability Companies are still relatively “new.” Their entity was first recognized in the 1970s as the offspring of both the corporate and sole proprietorship/partnership firm. Because of this dual nature, an LLC takes on the characteristics of both legal entities.
While most states have almost the same LLC laws, there are differences that may lead a business to choose to become an LLC in one state and a corporation in another. In time, LLC laws will become more uniform throughout the United States. For most businesses, these discrepancies between LLC laws should not be a factor. But the discrepancies may be the deciding factor for a few.
Both corporations and limited liability companies, offer its own benefits, separate the owners from the business with protection. How you will know which entity to incorporate a business as is now a choice that you have to make. Ultimately, deciding which entity aligns the most with your goals is an important step.
It is a suggestion that you speak with a licensed CPA or attorney. They can assist in answering any tricky questions you may have about which entity is right for your business.