Let’s learn about the advantages and disadvantages of a corporation to decide if incorporating is right for you.
There are many pros and cons. We will be covering a few in this article.
To summarize, some benefits of a corporation include protecting personal liability, security, business continuity, and easier access to capital.
Some downsides of forming a corporation include the procedure being time-consuming, subjection to double-taxation, and strict protocols to follow.
This article is for business owners trying to determine their business structure and determine whether a corporation makes sense.
There are a variety of options available when determining the legal structure of a company.
One option is to form a corporation. Everything brings its pros and cons.
To help you determine if a corporation is the best legal entity for your business, I have broken down different types of corporations and the benefits and drawbacks of incorporating them.
What Is A Corporation?
A corporation (any type) is a business recognized by the state as a legal entity separate from its owners. These owners are also known as shareholders.
The owners of a corporation can be individuals and entities. This ownership is easily transferable via the buying and selling of stock.
Being a legal entity on its own, a corporation protects its owners from personal liability in the case of legal action.
Usually, the business owners who like to have a more formal business structure than a limited liability company opt for forming a corporation.
Corporations are useful if they wish to take their business global or establish an IPO [initial public offering].
Every state’s legal requirements and regulations differ for forming a corporation. You must strictly follow your state’s legislation.
These requirements may include creating corporate bylaws and filing articles of incorporation with the state secretary. It may take weeks or even months.
I’d recommend taking help and guidance from an attorney and a tax advisor before you embark on your journey to forming a corporation.
These people are experts and help you figure out if it is the right legal structure for you. They can also help you in the documentation process.
How Do Corporations Work?
As we discussed above, corporations offer liability protection for each owner’s assets.
One or more shareholders own each corporation, and their ownership depends on the number of shares they own.
Corporation has a board of directors that is elected by shareholders. Every shareholder gets one vote per share in selecting the directors.
The board of directors oversees the management by hiring a management team.
The ownership of a company varies with the number of shares you hold. For this reason, corporation shares are easy to buy and sell.
This eventually makes the company’s ownership easily transferable, which is vital for business continuity and longevity.
Corporations can also conduct any legal business.
They can take actions necessary to conduct the business, like entering into contracts, owning assets, borrowing money, hiring employees, suing, and being sued.
What Are The Benefits Of Forming A Corporation?
Now let’s discuss the advantages of becoming a corporation.
A few are as follows
- Personal liability is limited
- Transfer of ownership is easy
- Continuity and security of business
- Tax benefits
- Better access to capital
Now let me discuss each of these benefits one by one.
- Protection of Personal Assets
A corporation ensures more personal asset liability protection to its owners than any other legal business entity type.
For instance, if someone sues a corporation, the shareholders are not personally responsible for corporate debts or legal obligations.
It doesn’t matter if the corporation doesn’t have enough money in assets for repayment.
Businesses choose to incorporate mainly because it protects their personal liability.
- Security and Continuity of Business
As we all know, ownership of a corporation is based on how much stock a shareholder owns.
This gives a corporation inherent flexibility of transferring the ownership and keep the business running in the longer run.
Thus corporations are easy to buy and sell. If a shareholder wants to leave, they can sell their stocks. Similarly, if an owner dies, their shares can be easily transferred to someone else.
- Can Easily Raise Capital
Corporations can quickly establish an IPO (initial public offering) and raise capital by selling stock. This is something that other business entities do not have access. This capital helps grow a company and saves it from going bankrupt on trying times.
- Occasional Tax benefits
Corporations are either C type or S type. S corporations have tax benefits. This classification depends on how you distribute the income.
S corporations can split the income between business and shareholders. This split allows the business income to be taxed at different rates.
What Are The Disadvantages Of Forming A Corporation?
Forming a corporation has its potential disadvantages. Thus I advise you to consult with an attorney before deciding to form a corporation.
Let’s look into the disadvantages of forming a corporation.
- The application process is lengthy.
The overall process of incorporating is usually long. Extensive paperwork is required to determine and document the organization’s details correctly and it’s ownership.
Some other tasks that you might have to do are
- Draft and maintain corporate bylaws,
- Appoint a board of directors
- Create a shareholder ownership change agreement
- Issue stock certificates
- And take minutes during meetings
- Strict protocols and structure
To maintain your corporation status, you have to follow many formalities and strict regulations that require an investment of both time and energy.
There are some restrictions a well like S-corp can only have up to 100 shareholders, who must all be US citizens.
- Probability of Double taxation
Yes, you may get double taxed.
The business income of C- corporations usually gets taxed first at the entity level and then at the shareholder level.
Hence, if you want to avoid double taxation, form an S-corp, and be vigilant to meet all legal requirements.
Otherwise, Uncle Sam has the right to tax you as a C corp if your records do not meet the S- corporation’s legal requirements.
- Can Be Expensive
Forming and operating any corporation can be expensive.
In addition to paying the documentation charges, ongoing fees, and double taxes, it requires much startup capital to get a corporation up and running.
Consult with an attorney before jumping on the idea of forming a corporation.
What Types Of Corporations Are There?
Some types of corporations are S corporations, C corporations, closed corporations, and non-profit corporations.
Each has its benefits and disadvantages. Let’s discuss one by one.
A-C- Corporations can have an unlimited number of shareholders. They can raise capital by selling stock shares, making this a preferred option for large business companies.
The C corp is taxed on its income as a separate entity. The shareholders of such an entity receive personal liability protection from business debts and litigation.
An S- corp avoids the issue of double taxation.
It passes its income, losses, credits, and deductions to the shareholders to be reported and taxed on their tax returns instead of the company being taxed as a separate entity.
All of the shareholders of S-corp must be US citizens. It can have no more than 100 shareholders.
- B corporation
A for-profit business structured to benefit society, B-corp is also known as a Certified Benefit Corporation.
B- Corp has rigorous criteria for the formation. It also maintains the same C-corp or S-corp tax status.
- Closed Corporation
A closed corporation is a privately held company owned by a few shareholders.
Such an entity is also known as a private company, family corporation, or incorporated partnership.
As the shareholders are few, raising capital is challenging; however, the owners enjoy protecting personal liability.
- Non-Profit Corporation
Non-profit corporations can be formed for social, scientific, literary, political, educational, religious, and charitable purposes.
Requirements to form such corporations vary from state to state.
Non-profit corporations are prohibited from distributing profits to members, directors, or officers;
However, they can pay wages and compensate the people who work for running the corporation.
Non-profits corporations have specific tax advantages, including the ability to file for non-profit, tax-exempt status with the state and federal governments.
Most non-profit corporations choose 501(c)(3) tax-exempt status.
This exempts the non-profit corporations from paying federal and state taxes as the non-profit corporation is pursuing a non-profit mission.
Let’s Sum It Up
From the above discussion, it is apparent that forming a corporation has its advantages and disadvantages.
Businesses can incorporate as a C-corporation, S-corporation, B corporation, closed corporation, or non-profit corporation. Each type has its requirements, purpose, and benefits.
This can be expensive, time-consuming. You may have to follow strict formalities and pay larger taxes.
It is wise to consult with an expert before forming a corporation. They will help you make an informed decision and can assist you in the filing process as well.
If a corporate entity is not suitable for your business, some alternatives are sole proprietorships, partnerships, LLCs, and cooperatives.
You can learn more about corporate alternatives by visiting BestLLCServices.co