 The
standard corporation, also called a C corporation,
is a very common business structure. Corporations
are separate legal entities that are owned by
shareholders. Conversely, sole proprietorships and
partnerships are not separate legal entities. They
are considered to be the same as the owner(s). In
order to form a corporation, the appropriate
formation documents, usually called the articles of
incorporation or a certificate of incorporation,
must be filed with the state and the state filing
fees be paid.
The primary advantage of incorporating a business is
the limited liability the corporate entity affords
its shareholders. Typically, shareholders are not
personally liable for the debts and obligations of
the corporation; thus, creditors will not come
knocking at the door of a shareholder to pay debts
owed by the corporation. In a partnership or sole
proprietorship the owner’s personal assets may be
used to pay debts of the business.
Other advantages of incorporating a business
include:
- Incorporating may establish credibility for a new
business with potential customers, employees,
vendors, and partners.
- The ownership of
a corporation is easily transferable through the
sale of stock.
- Corporations
have unlimited life extending beyond the illness
or death of owners.
- Certain
expenses, such as insurance, travel, and qualified
retirement plans are typically tax-deductible.
- Additional capital can be easily raised through
the sale of stock (shares) in a corporation.
The main disadvantage to forming a C corporation is
often considered to be the potential for double
taxation. C corporations are considered separately
taxable entities by the Internal Revenue Service
(IRS), and taxes must be paid on the profits of the
corporation. If a corporation then distributes its
profits to shareholders in the form of dividends,
the dividend income is also taxed as regular income
to the shareholders. In this case, the corporation’s
profits are taxed twice, first as income to the
corporation and second as dividend income to the
shareholder, creating the “double-tax.”
However, not all income a shareholder receives from
a C corporation is subject to the double tax. For
example, if the shareholder is also an employee of
the corporation, that shareholder will most likely
receive a salary payment from the corporation. As
long as the salary paid to the shareholder is
considered by the IRS to be reasonable (or similar
to the market salary rates for that position), it is
treated as a business expense and is deductible to
the corporation. This helps reduce the amount of
taxable income the corporation has.
In order to eliminate the possibility of double
taxation, C corporations can elect to be taxed as an
S corporation with the IRS. With S corporations, the
profits and losses of the corporation are reported
on the individual tax returns of the shareholders,
and any necessary tax is paid at the individual
level. This taxation method is called "pass-through"
taxation, since the profit or loss of the
corporation is passed through to the shareholders.
Other aspects of C corporations that can be
considered disadvantages include:
- Corporations are more expensive to form than sole
proprietorships and partnerships.
- There are more corporate formalities, such as
annual paperwork, and more state and federal rules
and regulations, than with sole proprietorships and
general partnerships.
When evaluating whether the corporate structure is
right for your particular business, it is advisable
to first determine the goals of your business, and
then to assess the advantages and potential
disadvantages of the different business structures
in relation to those goals. You may also wish to
seek the advice of an attorney or accountant.
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