Pros and Cons of Forming a Corporation
Learn about the benefits and drawbacks of forming a corporation to decide if incorporating is right for you.
- C-corps (double taxed) and S-corps are the two most popular forms of companies (not double taxed).
- Personal liability protection, company stability and continuity, and easier access to financing are benefits of forming a corporation.
- A corporation’s drawbacks include the time commitment, double taxes, and stringent formalities and procedures that must be followed.
- This article is for company owners who are attempting to decide on their corporate structure and if it is advantageous for them to do so.
Small company owners may choose from a range of choices when deciding on the legal framework. To set up as a company is one choice. Although there are many benefits to incorporating your company, there are a few drawbacks you should be aware of as well. We consulted with legal professionals to break down the many kinds of companies and the advantages and disadvantages of incorporation in order to assist you in deciding if a corporation is the ideal legal structure for your company.
A company is what?
A corporation is a company that the state recognizes as a distinct legal entity from its owners (also known as shareholders). Ownership of a company may be held by people, other legal entities, or both, and stock purchases and sales make ownership simple to transfer. A company may engage in litigation on its own and shield its owners from personal accountability since it is a separate legal entity.
According to Deborah Sweeney, CEO of MyCorporation, “this entity type is frequently chosen by entrepreneurs who wish to have a more formal business structure than that of an entity such as a limited liability company (LLC) and may eventually consider taking the business global or establishing an IPO [initial public offering].”
To form a company, you must adhere to the laws of your state. These conditions often include the writing of company bylaws and submitting articles of incorporation to the secretary of state. It may take weeks or even months to gather all the data necessary to submit your articles of incorporation, but once you’ve done so successfully, your company will be formally recognized as a corporation.
Before you decide to form a business, it’s a good idea to consult with an attorney and a tax counselor. These professionals can assist you in deciding if it is the right legal structure for you and in filing if it is.
How do businesses operate?
A corporation provides liability protection for each owner’s personal assets since it is a distinct legal entity from its owners. According to Feldman & Feldman attorney Shannon Almes, companies may typically engage in any legal activity and the activities required to do so, such as making contracts, owning property, borrowing money, recruiting staff, litigating, and being sued. A board of directors chosen by the shareholders typically oversees corporations.
According to Almes, each shareholder normally has one vote per share for choosing the directors. The administration of the corporation’s day-to-day activities is overseen by the board of directors, who often do so through appointing a management team.
According to the number of shares they possess, each shareholder of a corporation typically owns a certain proportion of the business. Ownership of a company is readily transferred since corporation shares are simple to acquire or sell. This is particularly advantageous for the lifespan and continuity of company.
What benefits come with creating a corporation?
Being a corporation has a number of benefits, such as less personal responsibility, simple ownership transfers, company continuity, greater access to capital, and (depending on the corporate form) sporadic tax benefits. The particular way your firm is set up will determine the legal form of your organization and the advantages you stand to gain from it.
Protection against personal culpability
More than any other business kind, a corporation shields its owners’ personal assets from liabilities. For instance, even if a business doesn’t have enough money in assets to cover its debts, its stockholders are not held personally liable in the event of a lawsuit. One of the primary reasons for firms choosing to incorporate is personal liability protection.
Business longevity and security
When transferring ownership and sustaining a firm over the long term, corporations, whose ownership is based on a proportion of stock ownership, give significantly more flexibility than other organization kinds.
Ownership of this company form is often simple to acquire and sell, while specifics surrounding transfer of ownership rely on the governing agreement in the bylaws and articles of incorporation. For instance, an owner may simply sell off their shares if they desire to quit a business. Similar to this, a deceased owner’s stock ownership may readily pass to a new owner.
Capital is available.
Since publicly listed stock is how most firms sell ownership, they may readily raise money by selling shares. Other company kinds do not have this luxury of finance access. It is excellent for business expansion as well as for preventing a company from going bankrupt when necessary.
Despite the fact that certain corporate forms (C companies) are vulnerable to double taxation, other corporate structures (S corporations), depending on how their revenue is allocated, may offer tax advantages. S firms, for instance, have the luxury of dividing their revenue between the company and shareholders so that it may be taxed at various rates. The balance of the company dividends will be subject to its own level of taxation, while any income identified as owner remuneration will be subject to self-employment tax (no self-employment tax).
What drawbacks are there to creating a corporation?
A company is not for everyone, and you could find that it ends up costing you more in terms of time and money. The following possible drawbacks should be considered before forming a corporation: There is a drawn-out application procedure, certain formalities and regulations to adhere to, it may be costly, and you can be subject to double taxation (depending on your corporation structure).
Arduous process of applying
The process of incorporating might be lengthy overall, however filing your articles of incorporation with your secretary of state can be rapid. To accurately ascertain and record the specifics of the company and its ownership, you may need to comb through a lot of documentation. Sweeney cited the necessity to establish a board of directors, design and maintain company bylaws, prepare a shareholders ownership change agreement, issue stock certificates, and record meeting minutes as a few examples.
Rigid procedures, rules, and organization
The time and effort required to properly operate a business and follow legal regulations is in addition to the drawn-out application procedure. To keep your corporate status, you must adhere to a lot of procedures and strict rules. For instance, you must abide by your rules, keep a board of directors in place, have yearly meetings, record board meetings, and provide annual reports. Additionally, there are limitations on certain company kinds (for example, S-corps can only have up to 100 shareholders, who must all be U.S. citizens).
The business income of the majority of companies (such C-corps) is taxed twice: once at the entity level and once at the shareholder level (based on their percentage of profits earned). Operating as a S company is the only way to get around this. By simply taxing each shareholder on their individual income and not at the corporate level, S-corps solve this issue. However, if S-corps’ records don’t comply with the law, the IRS has been known to pay more attention to them and even tax them as C-corps.
The creation and maintenance of corporations are costly. Although creating and sustaining a company might be expensive, it may be simple for existing firms to generate funds by selling shares. A lot of beginning cash will probably be required to get a company up and operating, in addition to paying the filing costs, continuing fees, and higher taxes. Consult an attorney and an accountant who are knowledgeable about the ramifications of forming a company while comparing the benefits and drawbacks to decide whether a corporation is the best legal structure for your business.
What kinds of businesses exist?
Companies may be classified as C corporations, S corporations, B corporations, closed corporations, nonprofit corporations, and more. Both have pros and cons. Sole proprietorships, partnerships, LLCs, and cooperatives are a few alternatives to corporations.
A C corporation (C-corp), one of the most popular forms of businesses, may have an unlimited number of shareholders and is subject to separate taxation on its profits. C-corp shareholders are exempt from personal accountability for corporate debts and legal actions, and they are not taxed on the profits they receive from the corporation. The division of ownership for this kind of organization is based on shares, which are readily purchased or sold. A C-corp is a typical kind of corporate company for big businesses since it may obtain funds by selling shares of stock.
Although S companies (S-corps) avoid the problem of double taxation, they are similar to C-corps in that the shareholders have limited personal responsibility. An S-corp is a pass-through corporation, which means that instead of the company being taxed separately from its owners, its income, losses, credits, and deductions may be transferred to the shareholders for reporting and taxation on their individual tax returns. S-corp stockholders are required to be US citizens only.
According to Almes, “the company must satisfy numerous standards in order to qualify as a S corporation, including not having partnerships, nonresident aliens, or other companies as shareholders; having no more than 100 shareholders; and having just one class of stock.”
Known sometimes as a B corporation or B-corp, a certified benefit corporation is a for-profit company set up to benefit society. For S companies and C corporations, this relatively new corporate structure effectively serves as a stamp of approval, attesting to their commitment (and legal obligation) to advancing society and the environment. You must fulfill stringent requirements, such as earning an 80 or above on the B Impact Assessment, publicly disclosing your scores on BCorporation.net, and signing a formal pledge to take your organization’s stakeholders into account, in order to become a B company. You may continue to file taxes as a C-corp or S-corp even after becoming a B-corp.
Shut down corporation
Several stockholders own a closed corporation, which is often referred to as a private firm, family corporation, or incorporated partnership. Although the proprietors of private organizations do not have unlimited personal responsibility, it might be difficult to generate cash for them since the shares are not publicly traded.
For religious, philanthropic, political, educational, literary, scientific, social, or beneficent reasons, business owners may establish a nonprofit company. There can be tighter regulations for nonprofit businesses in certain states. According to Almes, a nonprofit corporation’s primary distinguishing feature is that it is not permitted to distribute profits to its members, directors, or officers; nevertheless, nonprofit businesses are still permitted to pay salaries or fair remuneration for services done.
The opportunity to apply for nonprofit tax-exempt status with the state and federal governments is one of the unique tax benefits available to nonprofit organizations.
According to Sweeney, the majority of nonprofit businesses choose for 501(c)(3) tax-exempt status, which exempts qualified nonprofit organizations from paying federal and state taxes since they are pursuing a charitable objective.