LLC vs. Incorporation - Which One Is Better for Your Business?

Whether you consider opening an LLC (Limited Liability Company), S corp, or c C-corp, the first thing you should know is that your business will be recognized as an autonomous entity by the state. These three types of business formation are a good way of protecting your private assets from banks and creditors.

Although both LLCs and corporations protect their members/ shareholders against legal liability, these business entities differ from each other based on other criteria, including taxation, membership organization, management, and more. 

If you are evolving from a sole proprietorship, you are probably asking yourself whether it is better to open a corporation or an LLC. Our article discusses the advantages and disadvantages of picking an LLC vs. incorporation. Hopefully, it can help you learn more about each type of business structure and choose the right one for your next business venture. 

Starting Out

Understanding which business entity works better for you means you’ll need to be familiar with the basics. Even though there are companies out there that can help you finish the entire paperwork and incorporate your business from scratch, you still need to know what you want to run - an LLC or a corporation. 

A typical incorporation website will offer several business structures to choose from - LLCs, C corporations, S corporations, nonprofit organizations, etc.  So, is it better to have: an LLC or corporation?  Make sure that you understand the basics of both entity types before you try to answer that question. 

Firstly, both LLC and incorporated businesses are legal business entities that separate your private assets from your business. Whether you form an LLC or corporation, the shareholders and members will generally be safe - only the funds and assets of the dissolved firm will get appropriated.

Secondly, it is much faster and easier to establish an LLC than to form a corporation. Still, when it comes to the LLC vs Inc. debate, both types of business have their advantages and disadvantages, so let’s take a look at them in more detail.

Advantages of an LLC 

As already mentioned, it’s much easier to form an LLC than any type of Inc. Whether you choose to create an LLC on your own or hire a professional service, the entire paperwork can be completed online. Almost all states require articles of organization to form an LLC. After they are approved by the Secretary of State, your LLC will become an officially registered business entity.

The process of creating an LLC differs from state to state. Depending on the jurisdiction of your business, you’ll need to meet state-specific requirements. For instance, in some states, you’ll need to publish the entity formation in a local newspaper. 

Speaking about the difference between LLC and Inc. formation, we also need to emphasize that the first entity has a flexible ownership structure. An LLC business can have one or more owners, called members. Although it is not obligatory in all states, an LLC should have an operating agreement that outlines the roles and responsibilities of each member.

All LLC members should sign the document and a copy of it in private. If an operating agreement is not set up inside the company, the LLC will be administered by the default rules of the state that it was formed in.

Furthermore, the LLC management structure offers more opportunities when it comes to taxation. Depending on how you established your LLC - as a sole member or a multi-member business - you can choose how to pay income tax to the IRS. It's one of the main advantages of a limited liability company when comparing incorporate vs LLC businesses. For example, with an LLC business structure, you can choose to pay LLC taxes as a proprietorship and thus, avoid double taxation. 

Namely, the IRS regulates tax payments for LLCs, including those that have a sole proprietorship. As the only owner/member of an LLC, you don’t need to separate personal tax returns from business ones. You will report all profits and losses of your LLC on your personal tax reports, meaning that your LLC won’t pay corporate taxes. 

Disadvantages of an LLC

One of the main reasons people choose to open an LLC is to separate their personal assets from those related to their businesses. Even though solopreneurs report both personal and LLC finances on their personal tax reports, LLCs are entirely independent entities that own the business and its assets and liabilities.

Members of an LLC participate with the investments, but their private assets are completely protected from creditors in case the company fails to meet its financial obligations. However, this doesn’t mean that LLC members are entirely free of any obligations.

If a member of an LLC doesn’t work in accordance with the operating agreement, they will be responsible for breaking the established rules and might suffer various penalties depending on that agreement. Many LLC vs incorporation guides forget to mention that in some situations, an LLC can be automatically dissolved and all its obligations passed to its members.

This typically happens when LLC members don’t pay taxes on time, but there are other reasons too, such as the death of an LLC member.

The downside of opening an LLC as a sole proprietorship is that you will be responsible for your own taxes. You’ll need to report self-employment taxes to the IRS, which requires you to stay up to date with the social security and medicare taxes all the time.

Another disadvantage of forming an LLC is that states have different rules on opening and running such businesses. When choosing between incorporated vs LLC businesses, many business owners who want to run their company across multiple states will give up on LLC formation because of additional LLC paperwork required.

Advantages of a Corporation

There are two different types of corporations - C-corps and S-corps. Although it takes longer to register a corporation than an LLC, corporations bring certain benefits to their shareholders. They also offer more flexibility when it comes to profits and taxation - you can easily switch between accrual and cash-based accounting.

As with LLCs, where members are taxed on the profits of the company, S-corps pass on profit taxes to their shareholders. Obviously, taxes are paid on an individual level, meaning that taxation is not the most important factor when making a decision between LLC vs incorporated businesses. Like LLCs, S-corps don’t pay corporate taxes, meaning that they can save you some money.

Also, S-corps don’t pass on their debts in case of catastrophic losses. C-corps are similar but have to pay corporate taxes. The reason you’d want a C-corp is that they can have an unlimited number of shareholders, whereas S-Corps are limited to 100, and ownership requires being a US resident or citizen.

Disadvantages of a Corporation

While S-corporations can bring benefits regarding taxation, a C corporation is not very helpful in this regard, considering they are effectively subjected to double taxation. Since corporations are independent legal entities, they pay corporate taxes that are higher than regular ones. Additionally, shareholders pay taxes on dividends taken from the corporation’s profits. 

As mentioned earlier, a key difference between a corporation and an LLC lies in the formation process. While LLCs are easy to form, the creation of a corporation is a more complicated process. Moreover, corporations are more complex when it comes to management. The corporation laws require regular meetings, formal financial statements, board elections, and so on.

Forming an S-Corp (which is a superior choice for small-to-mid-sized businesses) is an even more complicated process, which is why many business owners opt for an LLC instead.

The Bottom Line

Both business entities have their advantages and drawbacks. Before deciding whether you will start an LLC or a corporation for your small business, be sure that you understand how both work and then choose the structure that works best for you.