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LLC vs Inc: Which One is Better?

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It can get confusing to know how best to structure a business, and it may sound like you’ve received conflicting advice.  What is right in one case, may not be right in another.  The right structure for your business will depend on the nature of the business, how you intend to grow it, and what you may want to do with it in the future.

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It’s impossible to plan for every eventuality, but considering the differences between limited liability companies (where the name is suffixed by LLC) and corporations (where the name is suffixed by Inc.) is highly recommended.

Liability Protection

Both LLCs and corporations are limited liability entities, meaning the businesses are legally regarded as separate entities from their owners.  This limits owners’ exposure to business debts and liability to what they invested in the business.  So, except in exceptional cases, an owner’s personal assets are protected if the business is sued, and vice versa.

Formation and post-formation Compliance

A corporation is formed by filing a document called The Articles of Incorporation and drafting bylaws.  An LLC is formed by filing Articles of Organization and drafting an operating agreement.  The Articles of Incorporation requires more information and certain statutory requirements that must be opted out of or changed if not desirable.

Both corporations and LLCs are required to submit annual returns (in some states bi-annual) and appoint and maintain a registered agent and office.  These, plus The Articles of Incorporation and Articles of Organization, are public records.  If you place a high value on privacy, an LLC might be preferable.

Ownership, profit distribution, and transferability of interest

The owners of a corporation are called shareholders, and an LLC has members. Both can have one or unlimited owners (although some states require LLCs to have up to five.)  Owners can be any individuals or other entities.

A difference arises in profit distribution, though, because corporations have to distribute profits based on shareholders’ percentage holdings.  An LLC can distribute profits between members as it wishes.  If some owners work in the business and others don’t, this may be your preferred route.

It is not as easy to transfer the interest of an LLC’s member as it is to sell shares in a corporation, or to issue new stock, potentially of different classes.  If you plan on getting external investors, a corporation might make more sense.

(Note – electing S Corp tax status as an LLC places restriction on ownership and profit distribution and stock.)

Taxation

Taxation is a key differentiator between LLCs and corporations.  Corporations are taxed separately to their shareholders at the corporate tax rate.  Whereas, LLCs are “pass-through” entities for tax purposes, meaning the profits are taxed in the hands of the members.

Corporate tax can be lower than the highest personal income tax bracket, but profits are effectively double-taxed because shareholders are taxed on any dividends they receive.

But, LLC members have to pay self-employment taxes on the total profits passed-through to them unless they elect to be taxed as an S Corp.  In that case, taxes like Social Security and Medicare are calculated only on the salaries they receive from the LLC (which must be reasonable.)

S Corps and LLCs receive benefits under the 2017 Tax Cuts and Jobs Act that corporations don’t, but S Corp status restricts ownership, which may be undesirable.

Management

Management is governed by statute and the formation documents of the corporation or LLC.  Corporations are required by statute to appoint a board of directors, who meet annually and appoint the management of the company.

LLCs can be either member-managed or manger-managed.  If you and your partners want to manage the day-to-day business activities, then an LLC might be better for you.  (Note – electing S Corp tax status as an LLC might place restrictions on the management structure.)

Record-keeping

Rigorous record keeping is required of both corporations and LLCs, but the requirements on the latter are probably less onerous.

There are pros and cons for both corporations and LLCs, and especially when it comes to tax, the differences can be very technical.  It is always advisable to seek expert advice before finalizing the structure of a business entity.

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