Business Start-Up 101 Taking the plunge: Corporations

Corporations: Of all business structures within the United states, Corporations are the most common due to its legal standing as a separate entity. If you are going to form this type of entity, then it is important to know the advantages and disadvantages of the two different corporate types available to you. General Corporations or C Corporations (C Corp) and S Corporations (S Corp) have some similarities, yet plenty of differences. Limited Liability Companies (L.L.C) are easier to form and operate with less headache. Prior to filing for one type or the other, research which type is best suited for your specific ideas for growing your business.

C Corporations provide a multitude of advantages to its founder and shareholders. Among those advantages, shareholders are not personally liable for debts and/or liabilities of the business and can offer shares in the company by selling to different investors to raise capital. The risk involved to both founders and shareholders limits any loss in the business up to the amount of their investment. Although the overall scope of C Corporations can seem quite complex, transferring of ownership to another person or company is seamless, while the rules for this type of entity is rather uniform across the U.S. Finally, if you are aware of and concerned about double taxation rules impacting C Corporations, be aware there are tax deductions available which could potentially reduce taxable income.

Additional advantages of C Corporations:

  • No limit to the amount of shareholders: C Corporations have no limit on the amount of shareholders which means a limitless amount of investors can inject capital into your business.
  • A perpetual existence: If a director, shareholder, or an officer decides to leave the company, the corporation will continue to function if perpetual existence is in place.
  • Income Splitting: C Corporations can split the profits generated by the company and losses incurred thus resulting in lower tax rates for the business and the owner(s).

Consistent with the different business structures, disadvantages are inevitable. The disadvantages that are most concerning and talked about often is double taxation, in which forming a C Corporation can be taxed both on the business and personal level. Unlike partnerships, where in some cases an agreement between two parties can be considered as the starting point, C Corporations can be costly during the initial start-up phase with fees totaling in the thousands in addition to costs associated with an attorney filing fees.

Additional disadvantages of C Corporations:

  • Government Oversight: As a result of complex tax laws associated with a C Corporation, government oversight is common due to the protections that is provided to owners against litigation from bad debts and other obligations.
  • Corporate Losses: Losses by C Corporations deemed as corporate losses can not be deducted as such but shareholders must report these losses on personal tax returns.
  • Formality Requirements: Unlike other non-corporate structures, C Corporations are required to file and keep the following in good standing: Corporate Bylaws, Articles of Incorporation, certificates of good standing, meeting minutes, etc. during the corporation’s lifetime

Although S Corporations present some similarities to C Corporations with owners personal liability being limited, the advantage S Corporations hold over C Corporations is the avoidance of double taxation. S Corporations are considered ’pass-through’ entities, which means income made by the shareholders are passed through directly to the shareholders individual tax returns.

Additional advantages of S Corporations:

  • Ease of Termination: Termination of an S Corporation is rather simple and can be done either voluntarily or involuntarily. For voluntary termination, a vote is required by shareholders who own outstanding voting shares totaling more than 50 percent. Involuntary termination can be the result of a failure to follow certain restrictions which have been placed on S Corporations.
  • Distributions not subject to payroll taxes: Shareholders who receive distributions in a S Corporation are not subjected to payroll taxes which allows shareholders to bypass taxes paid on Medicare, social security, and unemployment.
  • No accumulated earning tax: Unlike a C Corporation, S Corporations are not subjected to accumulated earning tax when excessive amounts of earnings are accumulated without some portion paid to its existing shareholders.

If you like the advantages a S Corporation can bring to your business, then consider the disadvantages as well and how certain restrictions can affect your long term growth potential. Because S Corporations are limited to no more than 100 shareholders, the potential to raising start-up capital can be limited. Also, S Corporations must be a domestic based business with its shareholders being U.S. citizens.

Additional Disadvantages of S Corporations:

  • Cash retention is minimal: Most shareholders require distributions to pay taxes on passed through income, thus making it harder to build up cash reserves for a S Corporation.
  • Single Stock Class: It is often difficult for S Corporations to raise capital through stock offerings due to the type of stock being offered. Identical rights and company asset distribution must be in place as it relates to dividends if the business is liquidated at some point in the future.
  • S Status Termination: A shareholder(s) transferring shares of stock to another company which is not allowable can cause the business termination or loss of S Status.

Last but certainly not least is a Limited Liability Company or (L.L.C). If you have reviewed each business structure so far and have not found a match suitable to the type of business structure you would like to file under, then consider an L.L.C. L.L.C.’s are some of the most commonly filed business structures in the U.S. and much like similar structures Subchapter S and Subchapter C, LLC’s protects owners from personal responsibility against debts and liabilities yet is flexible enough for all members of the L.L.C. to share in the decision making process. In addition, L.L.C.’s are considered pass-through entity’s (unless stated otherwise), which means profits made from the company go directly to members without government taxation on the company level.

Additional advantages of L.L.C.’s

  • Charging orders: Charging orders protects the interests of other members of the L.L.C. against judgements and lawsuits incurred by another member of the L.L.C.
  • Easy to start: When comparing the amount of paperwork needed for filing versus S and C Corporations, L.L.C.’s are much easier to start and can be done on your own even without an attorney.
  • Less Compliance Paperwork: Because L.L.C.’s are not regulated like general C Corporations, the compliance paperwork needed to maintain an L.L.C. is considerably less. Regular board meetings and meeting minutes, which are requirements of C Corporations are not generally required of L.L.C.’s

With any business structure, disadvantages are always a part of it. With L.L.C.’s, it is no different. If you are starting out with an L.L.C. and looking for investors, the likelihood of finding many to invest in your vision could be hard to find due to investors paying taxes on the annual earnings of the company even if the investor receives a distribution or not. Also, L.L.C.’s can not retain any of its year to year profits without the money either being shared with its owners or the money reinvested back to the business.

Additional disadvantages of L.L.C.’s

  • State Fees and Taxes: Depending on which state the L.L.C. is organized in, certain states may require your business to pay a standard flat fee or a fee that is based on its annual revenue.
  • Costs versus Sole Proprietorships: The costs associated with forming a L.L.C.’s are considerably higher in comparison to a sole proprietorship although the protection against litigation in forming a L.L.C. should be taken into consideration.
  • Transfer of ownership: Transfer of ownership in a L.L.C. can be somewhat difficult considering L.L.C.’s do not offer shares of stock to its owners.

Depending on what decision you make regarding the type of business structure you choose, be certain that you know what type of business structure serves the best interest of you and any potential business partners. There is no perfect business structure. As you can see, every business structure has a positive and negative side to it. Remember, whatever business structure you choose can be changed at a future date if you as a business owner feel change is necessary to suit your needs and goals.

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