What is a C-Corporation?
C-Corporation is a legal structure for a corporation in which the owners, or shareholders, are taxed separately from the entity. C-Corporations, the most prevalent of corporations, are also subject to corporate income taxation. The taxing of profits from the business is at both corporate and personal levels, creating a double taxation situation.
There are different types of corporations but for the purposes of this article all references to a “corporation” will be the C-Corporations. A C-Corporation is owned by shareholders who must elect a board of directors that make business decisions and oversee policies. In most cases, a corporation is required to report some information on either financial or business structure to the state each year to remain in good standing.
Corporations have several advantages as business entities, including limited liability for the shareholders. They have three levels of involvement, or management: shareholders, who own the stock in the company; the board of directors, who make major company and strategy decisions; and officers, such as CEO, CFO or other positions who manage the day to day operations of the business.
While many large companies are corporations, it is a viable option for small and mid sized businesses as well, and can be used for most all types of businesses or industries.
Advantages of Forming a Corporation
Limited Liability
Corporations create separation between the owners and the business. If you own a partnership or a sole proprietorship, from a legal standpoint you and your business are the same person - which is dangerous because you are going to be liable for any obligations and debts of the business. A corporation limits this personal liability of the shareholder, who are the owners, by putting legal separation between shareholders and the business. The corporation is responsible for its own debts and obligations, if the company is sued, the shareholders aren’t personally sued. There are some situations that would lead to shareholders being personally liable, so be sure to carefully manage your company set up as your business changes and grows in order to keep taking advantage of the limited personal liability.
Raising Capital
Corporations are the preferred business entity for investors, especially venture capital investors. Depending on the nature of your business and how much outside capital you’re going to need to raise (and from who), choosing a corporation as your business structure could be very advantageous. While you can always convert to a corporation, if you’re going to need money up front, and a large amount of it, it may be easier to just start out as a corporation.
Taxes
Taxes are one of those things that can be a positive and negative for corporations. On the positive side, corporations often gain tax advantages, such as the deductibility of health insurance premiums paid on behalf of an owner-employee; savings on self-employment taxes, as corporate income is not subject to Social Security, Workers Compensation and Medicare taxes; and the deductibility of other expenses such as life insurance. Business expenses can also be deducted in tax filings.
Legitimacy
Forming a corporation makes your business more official, and while that’s not necessarily a reason on its own to form one, it is an added benefit. It will also help avoid situations that some sole proprietors and general partnerships run into - clients, customers and vendors not taking them seriously because they haven’t taken the steps to form a formal business entity, which has been known to cost them clients, miss out on opportunities and make it harder to acquire the resources needed to operate the business.
Disadvantages of Forming a Corporation
Higher Costs
Compared to other types of business entities, sole proprietors, general partnerships and LLC’s, corporations usually have to pay higher filing fees to get up and running. Some of the state reporting requirements and tax implications of running a corporation may be more involved and require the assistance of professional guidance to avoid issues popping up down the road.
Corporate Formalities
Corporations have more corporate formalities than any other type of business entity, and while you may be able avoid some of them, you’re going to need to comply with any necessary legal and reporting requirements in order to remain in good standing. The specific requirements vary state to state, but in most cases a corporation will need to do some, or all of the following:
- Adopt corporate bylaws
- File an annual report in the state where you’re incorporated and in states where you do business
- Hold shareholder, director and special meetings
- Document meeting minutes and resolutions
- Maintain separate business finances
- Document company transactions and contracts in writing
- Record the issuance of new stock in the company’s general ledger and balance sheet
- Pay annual taxes and (in some states) a franchise tax
Double Taxation
Double taxation is the term used to describe the way taxes are imposed on the shareholders and corporations themselves, other types of business entities don’t have to deal with this issue.
The corporation is taxed on its earnings (profits), and the shareholders are taxed again on the dividends they receive from those earnings.
Another description of double taxation applies to shareholders who are also employees and owners of the corporation: the "owner" of the corporation receives a salary as an employee. This salary is taxed at the regular personal income tax rate.
In addition, the owner is also a shareholder. If the corporation pays dividends on the profits of the corporation, the owner must pay the tax on those dividends on his/her personal tax return.
Dividends are taxed at the shareholder's personal tax rate.
Let's Sum It Up
Corporation’s have many advantages and are appealing to many entrepreneurs across numerous industries. It’s important to consider what type of business entity when you are starting out, you can always change as you go, but it helps to get off to a solid start. Weigh the pros and cons with your particular situation and decide what’s best for you and take into consideration the other business entities that are available to you.
Ultimately, a corporation offers some real advantage especially over a sole proprietorship or partnership and can be the perfect entity for many small businesses.
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