Advantages and Disadvantages of Forming a Corporation: A Complete Guide

A corporation structure is an organized group of people with its own rules, regulations, policies, procedures, and goals.

Corporations are often called “persons” under the law, which means corporations have many rights, including privacy, life span beyond their founders and investors, the unlimited growth potential for capital gains, etc.

Many companies are corporations ranging from small family-owned businesses to large multi-national conglomerates.

Corporations must hold an annual meeting of the shareholders to vote on corporate officers and other corporate matters. Corporations have been around for a long time in many forms, from early Roman trading companies to modern-day Wall Street corporations.

How do corporations work?

A corporation is a way for entrepreneurs to achieve their goals and dreams by creating a separate legal entity that separates them from the products they sell.

A corporation has many benefits, including limited liability, reduced taxation, continuity, stability, and so on.

What are the advantages of forming a corporation?

The corporation advantages are limited liability, reduced taxation, continuity, stability, and so on.

Personal liability protection

  • A corporation separates the business and personal assets of the owners.
  • The corporation form of ownership handles business debt, lawsuits, and taxes.
  • Owners are not held individually responsible for business debt which means no matter how much is borrowed, the owners are not liable for it. This makes borrowing easier because banks or investors can feel more secure loaning money to a corporation knowing that if the company fails, they have only lost their investment with no recourse against individual shareholders.

Business security and perpetuity

  • A corporation can own property, enter into contracts and pay taxes.
  • A corporation has the power to buy, sell, lease real estate; hire employees; sue or be sued in its name; form partnerships with other companies; retain legal counsel; borrow money, and generally do anything a natural person can do.
  • A corporate charter (articles of incorporation) must be filed with the state government for this authority to take place. However, many states allow foreign corporations doing business within their borders to act without filing any additional documents.

Access to capital

  • Corporations are considered legal persons. This means corporations can borrow money, open bank accounts, and enter into contracts just like individuals.
  • Because of these qualities, corporations have access to more capital than unincorporated businesses, making it easier for the company to expand its operations or service offerings.

Continuity

  • The death or departure does not cause the corporation to dissolve unless the corporation has other shareholders who agree to continue the private company.
  • A corporation continues doing business after shareholders die, retire, or otherwise leave because they transfer ownership by written will or state laws governing intestate succession.
  • In contrast, a sole proprietorship cannot survive beyond one owner’s death, and partnerships must be continually refilled with new partners as old ones depart.

Tax benefits

  • Corporations are taxed separately from the shareholders.
  • The corporation pays taxes on its income, which means none of its money is taxed twice.
  • Corporations can claim all business expenses as tax-deductible because they own them and not the shareholder who benefits from them. This reduces a company’s taxable income and allows for more flexibility with budgeting than would be afforded to unincorporated businesses.

What are the disadvantages of forming a corporation?

The disadvantages of becoming a corporation are loss of privacy, greater administrative responsibilities, and higher costs.

Loss of privacy

  1. A business must file articles of incorporation when it is formed. This information becomes a public record available for anyone to see (including competitors).
  2. Corporations must also file annual reports disclosing ownership, officers’ names, and financial details.
  3. Shareholders may elect to keep this information private by filing an additional “Statement of No Public Record” with the Secretary Of State in their state if they want anonymity.

Administrative responsibilities

  1. While corporations offer excellent continuity, this benefit comes at a price because shareholders must take on increased management decisions.
  2. Shareholders/managers must meet regularly to discuss significant issues related to the company’s operation, such as purchasing the real estate, budgeting, and new hires.
  3. A corporation must also have an annual shareholders’ meeting in which these issues are discussed in-depth.

Lengthy application process

  1. Becoming a corporation is more complicated than other business types.
  2. The process can take several months, which means it may take longer to return on investment.
  3. A business seeking venture capital may find it harder to convince investors of its long-term potential given the extended application period required for incorporation.

Double taxation

The biggest problem with forming a corporation is the taxation issue. Shareholders pay tax on their salaries; federal and state taxes (FICA) are collected each time employees are paid. Corporations also must pay income tax on profits themselves to avoid “double taxation.” This can make it difficult for smaller businesses to become corporations because they cannot afford the extra expenses associated with salary payments.

Increased costs

Many services that a sole proprietorship and partnership receive free (or at reduced cost), such as finding suppliers or procuring credit, must be paid for by corporations because these services must be purchased commercially rather than through relationships developed over time.

This increases overhead expenses beyond those of unincorporated businesses.

Who can form a corporation?

Any individual or business entity (including S-corporations and LLCs) may form a corporation. However, foreign corporations must have an “Investment Green Card” to be considered qualified to engage in any business activities within the United States because they are not considered residents of America for tax purposes.

Additionally, some states require international businesses to demonstrate that their home country offers similar privileges for American companies that do business there before granting “foreign” status.

An individual wishing to incorporate should maintain at least $800 in the capital after paying incorporation filing fees; this sum is generally required by state law in order to incorporate. Corporate guidelines vary widely from state to state with Delaware offering the most comprehensive set of provisions but the cost is higher at $897.

What types of corporations are there?

There are five types of corporations: C corporation, S corporation, B corporation, Close Corporations, and nonprofit corporation.

1) Close Corporations– Are managed by a small group of individuals (2 to 20) who work in the corporation on a day-to-day basis or serve as members of an advisory board or committee which has limited power over major company decisions.

Because close corporations have fewer shareholders, they have fewer reporting requirements and lower ongoing fees than other forms of business entities. However, close corporation shares generally do not trade hands so it may be difficult to raise capital from outside sources unlike other types of corporations.

Additionally, shareholders can’t sell their shares if the majority objects because corporate governance rights are restricted under close corporation laws. Finally, those wishing to leave a business they own as part of a close corporation to their heirs or beneficiaries must receive consent from other shareholders or they will lose their ownership stake and managerial role in the corporation.

2) C-corporations– Are the most commonly used form of corporation. Ownership shares can be purchased and sold by outsiders which means limited liability, transferability, and traceability are guaranteed to shareholders.

These are not allowed to have any other business purpose besides generating profit. Director meetings are required annually but only for half a day or less while shareholder meetings must occur at least once every six months.

Though C-corporations pay the highest fees, their shares have tax-exempt status in many cases; this is especially beneficial for non-residents who use corporations as investment vehicles because they will owe no tax on dividends received from these companies.

3) S-corporation- A pass-through entity that allows business income and losses to flow through directly to shareholders’ individual tax returns rather than being considered corporate profits and losses; this makes taxation rules simpler for small businesses with few owners but it also means each owner is subject to individual taxation on the same earnings.

This form of business is generally limited to American citizens and resident aliens but it may expand to include Canadian residents in some states; certain restrictions apply, however.

4) B-corporations (benefit corporations)- Are for-profit companies with a stated public benefit purpose although they are allowed to make a profit like other corporations; this status was created by sustainable business advocates who felt traditional corporate level laws did not provide sufficient incentives for businesses to consider environmental factors when making decisions.

B-corps can be formed as S-corporations or C corporations but they must go through an approval process that determines whether their stated purpose is beneficial enough to receive certification. If so, directors are held legally responsible if they fail to uphold their stated purpose or if they expand into activities that are not consistent with the corporation’s public benefit.

5) Non-profit corporations– Are organizations that do not distribute profits to owners but instead focus on providing some kind of benefit to society; this form of organization is exempt from most taxes under the Internal Revenue Code and may be eligible for certain state benefits as well.

Does a corporation have to be formed in the state of operation?

No. Corporations are regulated by the state in which they are incorporated but can conduct business within any state that does not have an adverse effect on the corporation’s governing documents or place burdensome taxes on it.

Conclusion

Forming a corporation is generally the preferred choice for businesses wishing to incorporate but it’s not always required.

Not everyone can form a corporation and certain types of business may find they are better suited to other structures; sole proprietorships, partnerships, nonprofit corporations, and limited liability companies (LLCs) are often more cost-effective especially for small businesses.

To ensure you make the best choice for your unique needs, consult an attorney who specializes in legal issues related to your industry before making any final decisions about which business structure you will use.

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