Choosing between a Limited Liability Company (LLC) or Incorporation is essential because any business legal structure will affect your business operations, taxes, and funding. The structure of your company also influences how much of your personal assets are at risk. Thus, you should choose the one that balances your benefits and legal protection for your business and your personal assets.
While both the business structures can protect your personal assets, here are other essential factors you need to consider when choosing which one is suitable for your business:
Your net income is taxed when you reach the corporate level at 21%. Moreover, your shareholders would have to pay federal insurance contributions act (FICA) taxes and income tax on the dividends that they receive from your business’ profits. This is called ‘double taxation.’
Basically, when it comes to taxes on investors, the LLC investor needs to pay taxes even if they didn’t receive a distribution. Meanwhile, an incorporation investor only pays taxes if they receive dividends.
If you plan to carry profit into the coming tax year, an incorporation may be better because all gains that carry over are taxed at about 21%. On the other hand, an LLC member has to pay state income taxes, federal income taxes, and FICA taxes for the same scenario. This can result in less profit to carry over.
But if you want to grow your small business and pay LLC owners from your profits, an LLC could be a better choice. Instead of double taxation, your business will have pass-through taxation. This means that the owners will be the ones to pay the taxes on the dividends and net income they receive instead of the business.
2. Business Ownership
Ownership is another vital factor when comparing LLC vs Inc. Regardless of an LLC member’s financial contribution, the LLC can distribute its ownership stake to them. They’ll also receive the equal shares of profits that the LLC establishes in its operating agreement. Thus, you gain additional flexibility in business ownership.
The operating agreement of the LLC also contains the repercussions when an LLC member leaves and the subsequent procedure for transferring membership interest among the members. In addition, any trust, other incorporations, and foreign individuals can be an LLC owner. This will allow you to make suitable decisions for your business when you need help from such individuals or parties.
On the other hand, an incorporation has shareholders who can sell the business’ percentages and shares of stock. The shareholders then have the right to sell off stock or buy more to gain a larger percentage of the business. Unlike LLC, the business can still exist when a shareholder divests or leaves the company.
Incorporation has a stricter management structure than LLC. The former has officers to manage daily operations and a board of directors overseeing the business. It’s also vital that record-keeping and paperwork exist for director and shareholder meetings in the incorporation. Ideally, these meetings should occur every year.
Meanwhile, management in the LLC is unlike an incorporation. The owners of the LLC can delegate managers for the business, which makes them like passive investors. It’s also possible that the owners could also be the managers. They don’t require titles or traditional roles like Vice President or CEO as long as they have a suitable management structure.
4. Other Obligations And Filing
Annual filing obligations also differ between the two structures. Unlike incorporations, LLCs don’t require minutes of any company meetings or hold annual meetings at all. In some states, you don’t even need to file annual reports. This allows you to operate your business flexibly, especially when you’re just starting, since you don’t have to comply with tedious corporate requirements.
As mentioned, an annual shareholders’ meeting and annual report are necessary for all incorporations. They need to maintain, keep, and record the essential matters that the shareholders discussed during the meetings. This may include the framework for issuing forms of compensation, bonuses, and dividends.
5. Funding Opportunities And Options
Your business’s ability to receive funding is affected based on your business structure. This is important for business growth objectives, thus the need for investors.
You may find it hard to find venture capitalists and obtain financing from banks in an LLC structure. Besides, before receiving equity investment, your investor must become an LLC member or owner first. This means the investor can gain more rights to control the company.
The members can have a say in your business operations, although they can choose to become passive members. Accordingly, if you can’t generate funding, you may take out personal loans, which typically destroys the limited liability concept of your business.
For that reason, passive investors are more attracted to incorporations because of the split between management and ownership. Moreover, most governing documents don’t let venture capitalists invest in LLCs, making them prefer incorporations. In addition, most investors also want stock options that an incorporation can offer.
So if your business is capital-intensive, then an Incorporation is a better option because it’s also easier to obtain bank financing for your company.
Another factor that makes investors like incorporations better than LLCs is the financial rights. A shareholder’s percentage of the number of shares owned is the basis for distributions. For instance, a shareholder with 12% shares of the incorporation will receive USD$120 if your company has a USD$1000 dividend.
As mentioned, the operating agreement will be the basis of the distributions in an LLC regardless of their financial investment in the company. The operating agreement also allocates the annual losses and profits to the owners.
Meanwhile, shareholders don’t have a say on how dividends will be paid as it’ll be the directors’ responsibility. The allocation of losses and income will also depend on the percentage ownership in an S incorporation, while no distribution in a C incorporation.
By knowing the differences between an LLC and incorporation, you can better understand what structure is most suitable for your business. Typically, LLC is a good one if you’re a startup not needing more funding or you don’t want the hassle of more paperwork. But an incorporation would be better if you needed more investors for your business growth.