"Risk comes from not knowing what you are doing." - Warren Buffet. Determining the best legal structure for your business requires a healthy knowledge of the different business entity options and what they entail. Otherwise, owners face risks such as, paying too much in taxes or taking on too much liability.
Our blog series on Types of Business Entities covers areas to consider when deciding what business structure is the best for your business. Previously we discussed these areas in more detail regarding sole proprietorships, partnerships, and LLCs. This fifth post covers the tax and legal advantages and disadvantages of a corporation structure.
What is a Corporation?
According to the United States Small Business Administration;
"A corporation (sometimes referred to as a C corporation) is an independent legal entity owned by shareholders. This means that the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts the business incurs."
Corporations can be more complex than other business structures. They tend to have costly administrative fees and complex tax and legal requirements. However, shareholders benefit from having limited liability. Shareholders can be individuals, companies or other institutions that own at least one share of a company’s stock. Learn more about shareholders from Investopedia.
Areas to Consider:
There are different tax and legal advantages and disadvantages for each company type. The following areas help break down the different tax and legal differences between entity types.
Corporations take more effort than other entity types to form and are considered costly and time-consuming ventures to start and operate.
Establishing a Business Name: Requires more effort.
- Establish a business name. Note that either, "corporation", "incorporated", or "limited" is likely a requirement within the business name. However, state regulations vary.
- Register business name with your state government.
Business registration: Requires more effort.
- Contact your state business entity registration office to determine registration specifics. List of Secretary of State websites compliments of The Balance
- Depending on your state you'll be required to file articles of incorporation or other registration documents.
- You may also be required to establish directors and issue stock certificates to initial shareholders.
- Obtain all necessary licenses and permits.
Ongoing Administration: Requires more effort.
- There are reporting requirements, making corporations more complicated than other entity types.
Talent: Corporations offer competitive benefits and the potential for partial ownership through stock options. This may enable them to attract and retain high-quality and motivated employees more easily than other entity types.
Compared to other entity types corporations experience both advantages and disadvantages with regards to taxes.
Owners of a corporation only pay taxes on their salaries, bonuses, and dividends. Corporations pay taxes separately from their owners, based on the net profits of the corporation.
Tax on corporate profits can result in double taxation. When the company makes a profit, the corporation pays a tax on the profits. Then if dividends are paid to shareholders, the shareholders pay tax again on the dividend on their personal tax returns.
- Income tax - Corporations are required to pay income taxes.
Federal, State, & Local Taxes - These business structures are subject to federal and state taxes on their net profits. Depending on their locality, local taxes might also be applicable.
Corporations are required to maintain a balance sheet and income statement and record corporate minutes annually. The financial statements are used as the basis to complete the corporate tax returns. Comparatively, sole proprietorships don't require a separate business return or financial statements.
Depending on size and whether or not a corporation is publicly traded or privately owned, control may fall to the owners, shareholders, or board of directors. For example, in a publicly traded company shareholders only have control over electing the board of directors. The board of directors determine the direction of the company. In a privately owned corporation the owners/shareholders make all the decisions. Unlike sole proprietorships where there is always only one owner, control can be split between multiple individuals requiring more intensive processes for decision making.
With the ability to sell stock, corporations have an easier time raising capital than other structures.
Shareholders personal assets are protected from the risk of business debts and lawsuits. Only their investment in the stock of the company is at risk of forfeiture.
Corporations are independent legal entities.
Owners are referred to as shareholders.
Forming a corporation tends to be more costly, time consuming and complex than other entities.
Retaining higher-quality employees may be easier due to the available benefits.
Corporation profits can result in double taxation.
Annual financial statements and recorded minutes are required.
Control levels can vary.
Funding is gained through the sale of stock.
- This structure is usually recommended for larger more complex companies.
- IRS tax information on corporations.
- "Top 5 Mistakes in Forming Your Corporation" - Entrepeneur
- wikiHow to Form a Corporation
- "Five Rules For Selecting Your Personal Board Of Directors" - Forbes
- What are Bylaws for a Corporation? - the balance
Stay tuned for our next blog post of this series where we will be discussing the advantages and disadvantages of S Corporations.