We’ve arrived at the finale of our series covering the different business structures you might choose for your own business: corporations. We’ve already covered sole proprietorships, business partnerships, and LLCs, and now we’ll explore the ins and outs of what to know before you start a corporation.
From their benefits and drawbacks to other critical considerations before you go this route, here’s the overall gist of what you need to know about a corporation before deciding if it’s right for your business.
Catch the rest of the series here:
- Part one: Choosing a Business Structure: Sole Proprietorship (Part 1 of 4)
- Part two: Choosing a Business Structure: Partnership (Part 2 of 4)
- Part three: Choosing a Business Structure: LLC (Part 3 of 4)
What is a Corporation?
A corporation is a legal entity that does not depend on its founders to exist. Shareholders own a corporation and elect the board of directors to serve on it. The board hires corporate officers in a major corporation to oversee daily operations.
In contrast, corporate executives and directors are typically the same in small corporations.
Types of Corporations
There are two types of corporations: C Corporations and S Corporations. Non-profit corporations are another form, but they are beyond the scope of this article.
The designation depends on how one would elect to register with the IRS. It’s a tax designation where those who elect to be a Subchapter S have chosen to be taxed as a partnership.
As a C corporation, you will encounter “double taxation,” where the corporation pays its taxes, and then the shareholders pay their taxes.
Be sure to read to the end of this article for more information on S and C corps and why you might opt for one over the other.
How do you Start a Corporation?
Corporations are formed by submitting “Articles of Incorporation” and adopting corporate bylaws to the Secretary of State.
It can be challenging to manage a corporation because of the formalities you must follow.
This includes:
- Procedures for annual shareholder meetings
- Election of the Board of Directors
- Upkeep of corporate records
- Adoption of bylaws
- Complete separation of personal and business finances
- Correct filings with the secretary of state
Although many requirements may seem unnecessary for a small corporation, they are essential to preserving the corporate form. Maintaining the “corporate formalities” is critical to running a corporation.
Benefits of a Corporation
Now, let’s move on to some of the advantages of incorporation that might sway your decision in this direction.
Limited liability
As a shareholder in a corporation, you have limited liability—this means there’s protection for your assets in case of a lawsuit or business failure. Shareholders are not liable for the corporation’s business debts and legal judgments. This can provide peace of mind and financial security for the shareholders.
Ability to raise capital
A corporation can issue stocks, which can be advantageous if the business needs to expand or take on larger projects. Selling stock interests to individuals or other businesses is a common way corporations raise capital for their operations.
Professional image
A corporation can project a professional image and may be more attractive to customers, suppliers, and investors than a sole proprietorship or partnership.
Perpetual lifespan
A corporation has an endless lifespan, which means it can continue to exist even if the shareholders die or leave the business. This can make it easier to plan for the business’s long-term future.
Attracting talent
As a corporation, you may have an easier time attracting talented employees since the business may have more resources and a more established reputation than a sole proprietorship or partnership.
Tax benefits
Depending on the corporation’s size and structure, tax benefits may be available. These include deductions for business expenses and the ability to retain profits within the business and pay taxes at the corporate level.
Transferring ownership
Corporations can make it easier to transfer ownership, as it involves moving stock shares rather than the entire business. A business owner accomplishes this through the execution of stock purchase agreements and shareholder agreements with new shareholders.
These are just a few of the advantages of a corporation, but of course, there are drawbacks too, and those also need to be taken into account.
Disadvantages of Incorporation
Here are a few drawbacks to consider:
Complexity
Corporations have more complex compliance requirements and formalities than LLCs or partnerships, which can be time-consuming and costly for those managing the corporation.
This may include:
- Holding annual shareholder meetings
- Maintaining corporate records
- Following corporate governance rules
Also, profits are distributed based on the number of shares owned. S corps have a limited number of shareholders allowed, and the shareholders must be individuals.
Double taxation
C corporations are taxed separately from the shareholders, which means the business profits are taxed at the corporate level and then again at the shareholder level when they receive profits as dividends.
This can be disadvantageous compared to an LLC or S corporation, where the profits flow to the owners’ tax returns.
Difficulty in transferring ownership
Transferring ownership in a corporation can be more complex than an LLC or partnership, as it involves transferring shares of stock. This can be incredibly complicated if there are multiple shareholders or different classes of stock.
Limited flexibility
Corporations have a more formal and structured management structure, which can be less flexible than other business structures. This may make it harder to make quick decisions or adapt to changing circumstances.
Difficulty in dissolving
Dissolving a corporation can be more complex and costly than other business structures, as it may require legal filings and the distribution of assets to shareholders.
Here’s another article on business structure you don’t want to miss next: Choosing the Best Business Entity for Your Startup
S Corp vs. C Corp: What to Know
Now let’s return to that vital information about S and C corps we promised.
S corporations and C corporations are two types of business structures that offer different benefits and drawbacks for business owners.
Understanding the critical differences between these two structures can help you choose the most appropriate one for your business.
Taxation
One of the main differences between S corporations and C corporations is how they are taxed.
The IRS taxes S corporations like partnerships, with the profits and losses flowing to the shareholders’ tax returns. This means the business is not taxed separately from the owners, and the shareholders are responsible for paying taxes on their share of the business profits.
C corporations, on the other hand, are taxed separately from the shareholders. This means the business is taxed at the corporate level, and the shareholders are taxed on any dividends they receive from the company.
This is known as double taxation, as the profits are taxed twice: first at the corporate level and then at the shareholder level.
Structure
Another critical difference between S corporations and C corporations is their structure.
S corporations are limited to 100 shareholders and must meet specific requirements, such as being a domestic corporation and having only one class of stock.
C corporations, on the other hand, can have unlimited shareholders and issue different stock classes.
Which Structure is Right for Your Business?
So why would someone choose an S corporation over a C corporation or vice versa?
Tax benefits
If you expect your business to be profitable and you want to minimize your tax liability, an S corporation may be a good choice.
On the other hand, if you expect your business to be very profitable and you want to retain as much of the profits as possible within the company, a C corporation may be a better choice, as you can have the earnings within the business and pay taxes at the corporate level.
Because the profits flow through to the shareholders’ tax returns with an S corporation, you may be able to take advantage of personal tax deductions and credits not available to C corporations.
Size and ownership
An S corporation may be a good choice if you have a small business with few shareholders.
However, suppose you expect your business to grow, and you want to attract a more significant number of shareholders or issue different classes of stock. In that case, a C corporation may be a more appropriate structure.
Professional image
Do you want to project a more professional image and be taken more seriously by customers, suppliers, and investors? Then a C corporation may be a better choice.
C corporations are typically perceived as more established and stable than S corporations or other business structures, making them more attractive to external parties and investors.
Complexity
S corporations are generally less complex and have fewer compliance requirements than C corporations, making them easier to set up and operate. An S corporation may be better if you want to minimize your business’s administrative burden and legal fees.
However, a C corporation may be a more suitable structure if you are willing to invest more time and resources into compliance and corporate governance.
Conclusion: Call Us Before You Start a Corporation
At Contiguglia Law, we tend to be fans of corporations over LLCs. The formalities of a corporation make it a more mature choice for businesses. The corporate requirements impose obligations on the management, making them operate at a higher level and with more accountability.
Remember: you can change your business structure later if your needs or circumstances change. For example, you may start as a sole proprietorship and later convert to an LLC or corporation as the business grows, and you need to protect your assets or raise capital.
That being said, it’s generally easier and less costly to choose the proper business structure from the start, so it’s worth taking the time to research and make an informed decision.
Are you interested in learning more about the legal implications of different business structures and how to best protect yourself as a business owner? Contact Contiguglia Law today so we can help.
My book “Don’t Skip the Legal: The Startup Guide for Entrepreneurs and Business Owners” covers business structures and other key legal topics for business owners in detail. It’s available on Amazon—buy your copy today!
Did you learn a lot about what to know before you start a corporation today?
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