Inc vs. LLC – What are the differences?

Incs. is short for incorporated, and LLC is short for Limited Liability Company. For Inc., where the owner elected to be an S corporation, the profit and loss are passed to its shareholders, whereas income and loss in an LLC flow through to the members.

By: Brad Nakase, Attorney

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What is the difference between LLC and Inc? LLC is short for limited liability company, while the abbreviations inc. and corp. indicate that a company with these in their name is a corporation. A corporation grants shares of stock to its owners, who in this case are known as shareholders. Corporate shares are simple to transfer from one shareholder to another. This means that a corporation is a good structural choice for a business that plans on having outside investors or offering public stock.

The owners of an LLC, on the other hand, are known as members. Instead of shares, each member owns a certain agreed-upon percentage of the company, which is sometimes known as a membership interest.

It can be more difficult to transfer membership in an LLC than it is shares in a corporation. The operating agreement of an LLC will usually indicate whether and how membership interests can be transferred to other individuals.

Depending on the state, if a member departs an LLC and the operating agreement does not provide any guidance on the matter, then the LLC has to be dissolved.

In this article, our corporate attorney for starting a company discusses the difference between LLC and Inc. as follows:

What Is the Difference Between LLC and Corporation Taxation?

Corporations are taxed in one of two ways. As a default, a corporation is taxed as a C corporation, or C corp. This type of entity pays federal income tax on corporate profits and shareholders will also pay tax on the dividends they receive. Because the dividend amounts are taxed at both the personal and corporate level, this phenomenon is sometimes called double taxation.

If a corporation has 100 or fewer shareholders and follows certain other requirements, then it may qualify as an S corporation, through which it can avoid double taxation. An S corp does not pay corporate income tax, though the corporation’s profits pass through to the shareholders’ personal tax returns. Each shareholder must pay tax on their share of the profits.

LLCs have a more flexible tax structure. As a default, a single-member LLC is taxed similarly to a sole proprietorship. A multi-member LLC is taxed similarly to a partnership or corporation. This means that an LLC’s members report and pay tax on business income on their personal tax returns. Unlike corporate shareholders, members of an LLC might be liable for self-employment taxes.

What Is the Difference Between LLC and Inc. Management?

Corporations have a traditional and rigid management structure. For instance, a corporation needs to have a board of directors that establishes policies and oversees the company.

A corporation’s officers oversee the company’s day-to-day business. If a corporation is small, then one individual may play several different roles. They would be shareholders as well as director. If a corporation is larger in size, then shareholders are less likely to be involved in managing the business on a day-to-day level. A corporation’s bylaws detail the rights and responsibilities of the directors, shareholders, and officers.

As a newer entity type, LLCs were created to be more flexible in terms of management. A limited liability company may be managed by either its members or by a group of managers. Usually, when it is a member-managed LLC, the owners are very much involved in business operations, However, with a manager-managed LLC, investors often do not play much of an active role.

What Is the Difference Between LLC and Inc. Recordkeeping?

LLCs and corporations are both controlled by state laws, which will vary depending on the state in which the company was formed. Therefore, each state has its own rules regarding what records a business needs to keep, as well as what kinds of regular reports it must file with the state. Typically, there are more regulations and requirements concerning corporations than LLCs.

A corporation will be expected to hold a shareholder meeting once a year. Particular actions must be made valid via resolutions and kept in corporate minute boos. Many states want corporations to file reports annually, in addition to a fee.

There are fewer formal requirements when it comes to LLCs. For instance, in many states, LLCs do not have to file annual reports.

Corporations and LLCs are entities that are separate from their owners. If an entrepreneur is creating a new business, he or she should carefully review each type of business entity to determine which is right for them. The two entity types, LLCs and corporations, are discussed in detail below.

How to Start a Limited Liability Company, or LLC.

Owners of small companies often like the idea of a limited liability company (LLC), because it offers liability protection, flexibility in terms of management, and certain tax advantages. There are both advantages and disadvantages to making an LLC, so business owners should understand how to form this type of company and whether it suits their business.

Limited Liability Company (LLC)

A limited liability company is a type of company that provides a business owner with protection from liability and pass-through taxation. An LLC, like a corporation, is a separate legal entity. This means that owners of an LLC cannot be held responsible for business debts or obligations. It also means that an owner’s personal assets are safe in the event of a lawsuit. An owner’s car, home, and personal savings will be protected from judgement, meaning that he or she cannot lose them in a lawsuit.

An LLC is also eligible for pass-through taxation, because its income will not be taxed at the company level. That said, if an LLC has more than one owner, then it must still file a tax return. The business’ loss or income will be passed through to the owners, and the owners will need to document the loss or income on their personal tax returns and pay whatever taxes owed.

Benefits of Making an LLC

It is generally agreed that the advantages of forming an LLC outweigh the disadvantages. Some of the benefits include the following:

  • Limited Liability

Owners of a limited liability company, otherwise known as members, are protected from personal liability. Whatever the business or other members do is legally separated from the owner in question. Personal assets, such as homes, cars, and personal savings, are protected from creditors. These assets cannot be used to pay business debts. By contrast, the personal assets of general partners and sole proprietors can be confiscated to pay business debts.

It should be noted that an LLC can lose its limited liability. This action is called “piercing the veil.”

  • Flexible Ownership

Owners of an LLC may be individuals, partners, trust, or corporations. There can be any number of owners, or members. By contrast, an S corporation has many more restrictions on who can act as a shareholder, and there is a cap on how many owners there can be.

  • Management Structure

Owners of an LLC can manage their business, or they can choose a management group to do it in their place. By contrast, corporations are run by a board of directors and not the shareholders themselves. If an LLC is managed by its members (member-managed), then the owners themselves manage day-to-day operations. If the LLC is controlled by appointed managers (manager-managed), then the LLC works much the same as a corporation. In this case, management of the business falls under the responsibility of officers and directors, not the owners themselves.

  • Pass-Through Taxation

Normally, LLCs do not pay taxes at the entity level. The business’ income or losses are passed through to owners. The owners will then report the income or losses on their personal tax returns. Taxes, therefore, are paid on the individual level. C corporations, by contrast, are taxed at the company level and the shareholders are taxed on the distributed income.

  • Increased Credibility

By becoming an LLC, a company can benefit from increased credibility. Consumers and vendors will generally trust a limited liability company more because of the implied legitimacy.

  • Fewer Compliance Requirements

LLCs do not have to worry about state compliance requirements as much as general partnerships, sole proprietorships, or corporations (either S or C type). This is fewer formalities to have to worry about.

Disadvantages of Making an LLC

Even though generally the advantages of starting an LLC outweigh the disadvantages, it is useful to explore some of the negative aspects.

  • Cost. It is typically more expensive to create and run an LLC than it is a general partnership or a sole proprietorship. There is a formation fee, as well as ongoing fees imposed by the state. These fees may include annual reports and franchise tax fees. To look up the type and number of fees, an owner should check with his or her state’s Secretary of State office.
  • Transferable Ownership. It is usually more difficult to transfer ownership of an LLC than it is with corporations. For a corporation, stock may be sold to increase ownership, and shareholders can also sell their shares to another. However, with LLCs, all members have to agree to admitting new members or changing existing members’ ownership percentages.

Forming an LLC: the Steps

Forming an LLC is generally easier than forming a corporation. Still, there are administrative tasks to be completed and compliance requirements to be addressed. Luckily, the process of forming an LLC can be reduced to eight simple steps!

  • Step 1: Choosing a State

A business owner can choose any state in which to form his or her LLC, even if the company will not be conducting business there. Still, generally speaking, owners will choose to establish the LLC in the state where they mean to do business. This is most often the state in which the owner lives. If an owner chooses to register his or her LLC in a state in which they do not plan to do business, they will need to register the LLC as a foreign company in its home state. This can increase administration and formation costs.

Cost, taxes, and LLC laws are different depending on the state. Some states, such as Delaware, are popular choices with small business owners. The choice of state really depends on what amount of administration costs and duties one in willing to put up with.

  • Step 2: Choosing a Name

A business owner looking to form an LLC will have to select a name that is unique and available for use. This means that the name cannot already be in the Secretary of State’s records as the name of another business entity. Many businesses operate under a “doing business as”, or DBA. This is a name that can be used in place of the LLC’s official name.

In order to ensure that a name is available for use, an owner should do a company name search on the Secretary of State’s website. If an owner is not prepared to complete the formation process yet, he or she may still reserve the name for later use. This is a good idea, because the name might be taken otherwise. Many states will allow an owner to do this for a small fee and for a short time period.

Once an owner comes up with an original and available name, it is also advisable for them to do a trademark search. This will help the owner avoid infringing on intellectual property and confusing customers. For instance, there cannot be two cookie shops names “Jenna’s Baked Goods.” This would confuse customers and potentially violate one of these store’s trademarks.

  • Step 3: Select a Registered Agent

 When an owner forms an LLC, whether in California or another state, he or she needs to have a registered agent in the state where the company is formed. Don’t worry if you aren’t familiar with this term; in fact, many business owners have not heard of what a registered agent really is.

A registered agent is also referred to as an agent for service of process. He or she is appointed by an LLC to receive important legal documents such as notices, lawsuits, and tax documents for the LLC. These also include communications from the Secretary of State, such as annual reports and statements.

Technically, the owner of an LLC may be the LLC’s registered agent. However, there a few good reasons why a business owner should choose a registered service agent provider instead. For instance, if the registered agent is unavailable when time-sensitive documents are sent, or if the documents are mishandled, then the LLC will face big problems. It is best, therefore, to have professionals handle this kind of important matter.

Also, a registered agent should have a physical presence in the state. So, if one’s LLC is in California, an owner cannot appoint his cousin Jeff in New Jersey to be his registered agent. Sorry, Jeff! The owner will need to appoint a registered agent in California, and he may want to pick someone a bit more reliable than Cousin Jeff.

  • Step 4: Create an LLC Operating Agreement

 Almost every state requires that an owner create an LLC operating agreement. In most states, it can be created orally, but even so, it is a very good idea to have an operating agreement in writing. This document is an agreement between owners, or members, of an LLC. It details how the company will be operated. Even if an owner is the only member of an LLC, it is still good to have the formality of a written operating agreement. This demonstrates that an owner respects the LLC’s separate existence and can help prevent piercing the veil (losing limited liability status). This can be a chance for an owner to put into writing what will happen in certain situations, such as when the owner cannot run the business. It is possible for the owner to put in terms regarding how he or she wants the company to be handled after his or her exit.

It is very important that LLCs with multiple members have an operating agreement in writing. The document will detail the division of ownership, as well as profits and labor. The agreement can thereby help prevent disputes between owners. The document also lists who has what authority, and how votes should be conducted among members. It also lists how new members will be added, how membership interests can be transferred, and how profits and losses will be distributed. In order to be sure the agreement is comprehensive, it is a good idea to have an attorney look over it.

  • Step 5: File with the State

 An LLC does not officially exist until LLC formation documents are filed with the Secretary of State’s office. These documents are known as a Certificate of Organization, Articles of Organization, or Certificate of Formation. Filing fees will vary based on the state.

You may have heard of LLCs being “incorporated.” Technically, the correct way to talk about an LLC’s formation is to say that it has been “organized” or “formed.” “Incorporation” or “Articles of Incorporation” refer to the creation of a corporation.

Each state will have different requirements when it comes to the formation of an LLC. That said, there are certain common elements, which include the following:

  • Name, main location, and reason for business
  • Registered agent’s address and name
  • Will the LLC be manager-managed or member-managed

Standard Articles of Organization are available from each state for owners’ use. The person forming the LLC needs to sign the document. Depending on the state, the registered agent may also need to sign.

When the Articles have been submitted, the state will respond by issuing a certificate or other document providing confirmation. This certificate functions as legal proof of the company’s status as an LLC. The certificate may also be used to establish a business bank account, get an EIN, etc. Sometimes, it is necessary for a business to also publish a notice in a newspaper declaring the formation of the company. This will depend on the state in which the Articles are filed.

  • Step 6: Get an EIN

 Once an owner establishes his or her LLC, they must file with the Internal Revenue Service (IRS) to receive an employer identification number (EIN). An LLC will use this number on all of its bank accounts and tax filings. If an LLC wishes to do business in another state, then it must apply to that state’s tax department for a sales tax identification number. It must also register with that state’s department of labor.

  • Step 7: Open a Bank Account for the Business

 While this step is not legally required, it is a good idea for any LLC owner. Because the business is now a separate legal entity from the owner, it is essential to separate person finances from business finances. When a court considers whether to “pierce the veil” and potentially remove limited liability, it will look at this factor – whether finances are separated. Therefore, it is crucial that an LLC owner opens a business bank account. A business credit card can help keep personal and business expenditures separate, and it can also help build business credit.

Banks will generally request certain details: business type, formation date, as well as owners’ addresses and names.

  • Step 8: Register in Other States (Optional)

 Sometimes an LLC will want to conduct business in a state(s) other than that in which it formed. In this case, the owner will have to register, or foreign qualify, in each of the other states. This process requires submitting an application to the Secretary of State. Often, a Certificate of Good Standing is also required. The company will also have to choose a registered agent in the “foreign” state.

There are several factors used to assess whether an LLC is actually conducting business in a state and needs to “foreign qualify.” Some of the guidelines include whether the company:

  • Has workers in the state
  • Has a physical location in the state
  • Takes orders in the state

Each state will have different criteria for what qualifies as conducting business.

LLCs Versus Other Business Types

 An important step in creating a business is to decide on a business structure that suits the company and owner. There are several types of businesses, each with its own advantages and disadvantages.

  • LLCs Versus S Corps

 Both an S corporation and an LLC have pass-through taxation. That said, S corporations do not have the same flexibility in distributing income to owners – LLCs have this advantage. An LLC can also offer different classes of membership interest, while an S corp can only have one class of stock.

  • LLCs Versus Sole Proprietorships and Partnerships

 The big difference between LLCs and proprietorships and partnerships is liability. The owner of a sole proprietorship, or the owners of a partnership, are liable for actions taken by the company. This means that if the company faces a lawsuit or owes a debt, the owner or owners could lose their personal assets in a judgement.

How to Start a Corporation, or Inc.

A corporation is a separate legal entity which can protect its owners from business liabilities and risks. There are many benefits to starting a corporation. A business owner can save money on taxes, protect his or her own assets, attract the interest of investors, or simply enhance one’s credibility among consumers and vendors.

Let’s review how to start a corporation in California.

  • Choosing a Business Name

When an individual sets about creating a corporation, the first step is to choose a name for the business. In most states, it is necessary to include some indication of corporate status, such as “Inc.,” or “Co.”

In California, no two corporations can have the same name, or one that is very similar. Therefore, when a business owner believes he or she has come up with an original name, it is good practice to do a trademark search first. This way, he or she will not infringe on any existing trademarks.

Additionally, there are some words that cannot be in a corporation’s name. These words include “bank,” and “insurance.”

It is always possible to verify that a name is available and legal by checking with the relevant Secretary of State.

  • Registering a DBA

In some cases, a company may wish to do business under a different name than its official corporate name. The company would have to register a second name that keeps the identity of the corporation separate from the name used for business.

This second name may be known as DBA, or “doing business as.” It may also be referred to as an assumed name or a trade name.

The laws regarding DBA names vary by state, so it is a good idea to check with the relevant state’s Secretary of State office.

  • Appointing Directors

Typically, upon creating a corporation, an owner will appoint directors. The owner can appoint themselves as director, as well as others. A director has the following responsibilities:

  • Governing the corporation
  • Managing business and affairs
  • Electing officers
  • Attending corporate meetings

How many directors a corporate requires will depend on the specific state’s laws.

  • Filing Articles of Incorporation

In order to create a corporation, a business owner will need to fill out and file Articles of Incorporation with their state’s Secretary of State office. This establishes the corporation as its own legal and business entity.

Normally, Articles of Incorporation include the following:

  • Name and address of the corporation
  • Purpose of the corporation
  • Number and type of shares of stock to be issued
  • Name and address of the registered agent

What is a registered agent? This is the contact person listed for one’s corporation. He or she will receive service of process notices, correspondence from government agencies, and legal documents on behalf of an owner’s corporation.

Other names for Articles of Incorporation include: Certificate of Formation, and Certificate of Incorporation.

  • Writing Bylaws

When an individual creates a corporation, he or she must also create corporate bylaws. These are rules that define how the corporation will be run and managed.

Bylaws usually cover topics such as:

  • The number and type of shares the corporation can issue
  • How many directors the corporation can have
  • Corporate procedures such as meetings and record-keeping

States do not normally require that corporations file their bylaws. That said, writing bylaws is still an important step in incorporating that should not be skipped. It may be helpful to hire a corporate lawyer to assist in writing bylaws.

  • Drafting a Shareholder Agreement

A shareholder agreement can help protect the interest of shareholders in the event of certain situations. These situations might include:

  • The owner’s death
  • The owner transfers ownership of their shares

While this is not a mandatory document, it is nevertheless helpful to have.

  • Holding a Board of Directors Meeting

It is important that an owner hold a first meeting of the board of directors, regardless of how many directors the corporation has. This initial meeting is important, because it establishes the direction the company will take, offers any clarifications, and sets a precedent for how the company will be managed.

This first meeting should cover the following topics:

  • Corporate bylaws
  • Corporate officers
  • Issuing stock

It may also be the time to discuss whether or not the corporation should be classified as an S corporation. This decision would need the approval and vote of the board.

  • Issuing Stock

Stock is issued to help finance a corporation. Once the board of directors approves the issuance of stock at the initial board meeting, it is possible to start issuing stock to investors.

This is where bookkeeping comes in handy. With stocks, it is important for a business to record the following information: The purchaser of the shares; How many shares were bought; How much the shares cost; When the shares were bought.  Often, stock is issued in the form of a physical certificate or as digital shares.

  • Getting Business Licenses and Permits

A corporation may only start conducting business once it receives the required permits and licenses. The nature of these permits and licenses will depend on the following:

  • City and country laws
  • State and federal laws
  • Specific industry regulations

It is possible to check one’s state requirements on the Small Business Administration website.

  • Registering the Business

A corporation will require its own specific tax ID numbers. ID numbers will likely be required from the Internal Revenue Service (IRS) and the specific state’s revenue agency.

A corporation’s tax rate will depend on the state it operates in as well as the type of corporation it is.

  • Opening a Bank Account

When starting a corporation, it is necessary to open a corporate bank account. This account will be separate from those of the owners, which will help protect personal savings and funds from being lost in a lawsuit.

Depending on the bank, different documents may be required to set up the account. Examples of required documents include the following:

  • Corporate resolution
  • Articles of incorporation
  • Employer identification number (EIN)

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