LLC vs Inc.: A Comprehensive Comparison with Taxation Insights
- T Anagesh
- Jul 31
- 7 min read
Updated: Oct 7
Table of Content
In the dynamic world of business formation, entrepreneurs and business owners are often faced with a fundamental question that, Should I form a Limited Liability Company (LLC) or a Corporation (Inc.)
Both of these business structures offer unique benefits and challenges, and the choice between them can have long-term implications for taxation, legal liability, ownership structure, and operational flexibility.
This blog aims to demystify the distinctions between LLCs and corporations, especially focusing on one of the most nuanced areas, “TAXATION”
What is an LLC?
A Limited Liability Company (LLC) is a hybrid business entity that combines the liability protection of a corporation with the tax efficiencies and operational flexibility of a partnership. LLCs are governed by state law, and while each state has its own rules, the fundamental characteristics remain consistent across the board.
One of the most attractive features of an LLC is the concept of “limited liability.” This means that members (owners) of the LLC are not personally liable for the company’s debts or liabilities. Another defining characteristic of LLCs is their flexible management structure. LLCs can be member-managed or manager-managed. There is also no requirement for a board of directors, annual meetings, or other formalities typically required of corporations, which makes them particularly appealing to small businesses and startups.
From a taxation standpoint, LLCs are highly versatile. By default, a single-member LLC is taxed as a sole proprietorship, while a multi-member LLC is taxed as a partnership. However, the IRS allows LLCs to elect to be taxed as a C Corporation or an S Corporation (if eligible).
What is an Inc. (Corporation)?
A corporation, often referred to as “Inc.” (Abbreviation for incorporated), is a legal entity that is separate and distinct from its owners. Unlike an LLC, a corporation is more rigid in terms of structure. It is required to have a board of directors, officers, bylaws, and regular meetings. These formalities make it a more structured vehicle, often preferred by investors, especially venture capitalists and institutional stakeholders.
Corporations offer strong liability protection. Shareholders are not personally responsible for the debts and liabilities of the corporation. However, corporations are subject to more regulations and oversight than LLCs.
From a taxation standpoint, corporations can be taxed in one of two ways: as a C Corporation or as an S Corporation (if eligible).
By default, a corporation is classified as a C Corporation for tax purposes. However, it may elect to be treated as an S Corporation by filing IRS Form 2553. An S Corporation is a pass-through entity, meaning its income, deductions, and credits are passed through to the shareholders, who report them on their individual tax returns, regardless of whether any distributions are actually made. To qualify for S Corporation status, the corporation must meet specific IRS requirements, including having no more than 100 shareholders, all of whom must be U.S. citizens or resident aliens, maintaining only one class of stock, and paying reasonable compensation to any shareholder-employees who provide services to the business.
Understanding the Impact of C Corp and S Corp Elections
Default Tax Treatment
LLC (Limited Liability Company)
By default, the IRS does not consider an LLC a separate taxable entity. Instead:
A single-member LLC is treated as a sole proprietorship.
A multi-member LLC is treated as a partnership.
In both cases, the profits "pass through" to the owners (called members/partners) and are reported on their individual tax returns. This avoids double taxation.
Corporation (Inc.)
By default, an Inc. is taxed as a C Corporation under Subchapter C of the Internal Revenue Code:
The corporation pays tax on its profits (21% federal rate).
When dividends are distributed to shareholders, they also pay personal income tax on those dividends.
This results in double taxation once at the corporate level and again at the individual level.
Electing to Be Taxed as a C Corporation
LLC as a C Corporation
An LLC can elect to be taxed as a C Corporation by filing IRS Form 8832.
If the LLC wants to retain profits in the company without distributing them to members, this election makes sense.
Helpful for venture-backed startups, especially tech companies planning to reinvest heavily in growth.
Example: An LLC with two co-founders earns $500,000 in year one. They want to reinvest everything into product development. If taxed as a partnership, they would each be taxed on $250,000, even if they didn’t receive any money. By electing C Corp taxation, the LLC pays 21% corporate tax, and the members pay no personal tax unless dividends are paid later.
Corporation (Inc.) as a C Corporation
This is the default taxation status for a corporation.
No election is needed unless it previously elected S Corp status and wants to revoke it.
C Corp status is ideal for companies planning to go public, offer stock options, or raise institutional funding.
Example: An Inc. earns $300,000 in net profit and retains all earnings. It pays $63,000 in corporate taxes (21%). If it later distributes $100,000 to shareholders, those dividends will be taxed again on the shareholders’ personal returns.
Electing to Be Taxed as an S Corporation
LLC as an S Corporation
An LLC can elect to be taxed as an S Corporation by filing IRS Form 2553 (after making Form 8832 election if required).
It allows the owners to split their income between salary (subject to payroll tax) and distributions (not subject to self-employment tax).
Suitable for businesses with steady income where owners are actively involved.
According to IRS Requirement, there are certain criteria, for an entity to be served as an S Corp Status. Such criteria are as follows,
Must have 100 or fewer shareholders/members
All must be U.S. citizens or residents
Can issue only one class of stock
Example: A single-member LLC earns $200,000 annually. If taxed as a sole proprietor, the entire amount is subject to self-employment tax. If taxed as an S Corp, the owner pays themselves a reasonable salary of $100,000 (subject to payroll taxes), and the other $100,000 as distributions, which are not subject to self-employment tax, resulting in tax savings.
Corporation (Inc.) as an S Corporation
A C Corporation can elect to be taxed as an S Corporation by filing IRS Form 2553, as long as it meets the same eligibility criteria (100 shareholders, U.S. persons, one class of stock).
To avoid double taxation by passing profits and losses directly to shareholders.
Suitable for closely held corporations or family-owned businesses.
Example: An Inc. earns $120,000. As an S Corp, it passes that income to three shareholders equally. Each report $40,000 on their individual tax return. If no distributions are made, they still pay tax on that $40,000, since S Corp shareholders are taxed on income when earned, not when distributed.
The ownership structure of an LLC is highly flexible. Members can be individuals, corporations, other LLCs, or even foreign entities. There is no limit on the number or type of owners and profit distribution can be customized in the LLC’s operating agreement.
Corporations, especially S Corporations, have stricter rules. S Corporations can have no more than 100 shareholders, all of whom must be U.S. citizens or residents. They can only issue one class of stock. Whereas, C Corporations can issue multiple classes and attract venture capital more easily.
Let us go through certain examples to get an idea about the Tax Implications.
A startup with four co-founders incorporates as a Delaware C Corporation, raises $5 million, and issues preferred stock. Despite double taxation, the structure supports investor expectations and growth.
LLCs and Corporations both offer legal protection and flexibility, but the differences in taxation and structure matter. LLCs offer adaptability, while corporations provide investor readiness. Consult a legal or tax advisor to make the best choice for your goals.
If you need help structuring your business entity or exploring the tax implications of LLC vs Inc., feel free to connect with us at Ikshana Z Inc. Our team of experts is here to help you every step of the way.
FREQUENTLY ASKED QUESTION
1. How are LLCs taxed by default?
Single-member LLC: Taxed as a sole proprietorship
Multi-member LLC: Taxed as a partnership
In both cases, profits pass through to the owners' personal tax returns, avoiding corporate-level tax.
2. Can an LLC elect to be taxed as a C Corporation or S Corporation?
Yes. An LLC can:
File Form 8832 to be taxed as a C Corporation
File Form 2553 (after 8832 if needed) to be taxed as an S Corporation
These elections can offer tax planning advantages depending on income level and business goals.
3. What is the default tax treatment of a corporation?
By default, a corporation is taxed as a C Corporation, meaning:
It pays 21% corporate income tax on profits.
Dividends paid to shareholders are taxed again on their personal returns (double taxation)
4. What is an S Corporation and how does it differ from a C Corporation?
An S Corporation is a tax election that allows pass-through taxation, avoiding double taxation. However, it has strict eligibility rules:
Maximum of 100 shareholders
All shareholders must be U.S. citizens or residents
Only one class of stock allowed
5. Why would an LLC choose to be taxed as a C Corporation?
LLCs that plan to reinvest profits instead of distributing them may benefit from the 21% corporate tax rate. This strategy is common among tech startups preparing for rapid growth or venture funding.
6. Can a corporation switch from C Corp to S Corp?
Yes, a corporation can elect S Corp status by filing Form 2553, provided it meets the IRS eligibility criteria. Timing and planning are critical when making this switch to avoid unintended tax consequences.
7. What are the ownership restrictions for LLCs vs. S Corporations?
LLCs: No restriction on number or type of owners. Can include individuals, entities, and foreign persons.
S Corporations: Up to 100 shareholders, all must be U.S. citizens or residents, and only one class of stock is allowed.
8. How do I decide which is best: LLC or Corporation?
The best structure depends on:
Your growth and funding plans
Tax strategy
Type of ownership
Industry expectations
Consulting a legal or tax advisor is highly recommended for a decision tailored to your specific goals.
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