Corporation: Advantages & Disadvantages
What is a Corporation?
A corporation is a formal business structure where the business itself is treated as a separate entity from the business owners. The business owners become shareholders and every shareholder enjoys limited liability, meaning that shareholders are not personally liable for the debts or actions of the corporation. A corporation can be formed with one or more persons and is managed by a board of directors who then authorize officers (CEO, CFO, Secretary, etc.) to handle the day-to-day business operations. Under California law, a corporation must have at least three directors unless there are less than three shareholders (business owners). If there are two shareholders, then there needs to be at least two directors are and if there is only one shareholder, then there needs to be at least one director.
Also, a minimum of three officers need to be elected, but multiple offices can be held by the same person. The minimum three officers are:
Chairperson of the board or president (or both)
Chief financial officer.
There are two main different types of corporations:
C Corporation (standard and is the default type)
S Corporation – a C corporation that has made an “S election” with the IRS (IRS Form 2553), which means that the corporation chose to be taxed differently than a C corporation.
The Difference Between a C Corporation and a S Corporation
Normally, a C corporation is “double taxed” as follows:
Profits that the corporation made are taxed at the entity level, meaning that the corporation itself will pay taxes on the profits it made
Later when the corporation distributes the profits to its shareholders, the shareholders will then pay taxes on all the profits that they received on their own personal income tax forms
The S corporation avoids the double taxation that C corporations are hit with by not having to pay any taxes at the entity level. Instead, the taxes flow through to the shareholders as they pay taxes on the profits they receive on their own personal income forms. There are restrictions for forming a S corporation, such as not having more than 100 shareholders.
Three Main Sub-Types of Corporations
Each type of corporation can also be modified to become a sub-type of a C or S corporation:
(1) Benefit Corporation
A benefit corporation is a corporation that has a dual purpose of maximizing profits while pursuing a “general public benefit.”
Under California law, a general public benefit is "a material positive impact on society and the environment, taken as a whole, as assessed against a third party standard."
In other words, the corporation must work towards and actually have a significant positive impact that benefits society as a whole, which is measured by a standard set by a third party.
You can search and choose which third party standard you would like your benefit corporation to follow here
(2) Social Purpose Corporation
A social purpose corporation is a corporation that has a dual purpose of maximizing profits while pursuing a social purpose.
Unlike a benefit corporation, a social purpose corporation does not need to have its social purpose evaluated against a third party standard.
The social purpose must be adopted in the Articles of Incorporation and can only be changed by a supermajority vote by the Board of Directors.
(3) Professional Corporation
A professional corporation is a corporation for professionals who all practice in the same profession (such as law, accounting, engineering, etc.).
Not all professionals are allowed to form a professional corporation. Contact your applicable professional board to see whether your profession is allowed to form a professional corporation.
A professional corporation generally enjoys the same advantages and disadvantages of a C corporation and can even decide to become a S corporation.
Advantages of a Corporation
Limited liability for you and co-business owners – Everyone will not be personally liable to the actions of every other person or to any debts the corporation takes on
Increased financial resources – As a corporation, you can secure funding from investors as you issue them shares (ownership percentages)
Investors are the most familiar and feel the most comfortable dealing with corporations
Issuing shares allows you to divide the ownership of your business into fragments
Legitimacy – Investors and other businesses will see your business as having more legitimacy when they know it is a corporation and will take your business more seriously
Disadvantages of a Corporation
Ongoing compliance upkeep – There are numerous corporate and legal formalities that you must follow and observe in order to keep the corporate limited liability protection
Failing to follow the formalities may result in your business losing limited liability protection for you and other co-business owners, meaning that you and everyone may become personally liable to paying off the corporation’s debts
Not easy to form – There are numerous documents to create and file and ongoing compliance matters to keep track of even after forming the corporation
Relatively expensive – With more documents to create and file, there are added costs to pay to file the documents and additional legal fees in creating the required documents
Double taxation –
(1) The corporation will first be taxed for all the profits it made as a separate business entity from all the shareholders and
(2) When the corporation distributes those profits to the shareholders, they will have to pay taxes for all the profits they receive
Franchise Tax Board tax – A corporation will have to pay the California Franchise Tax Board a tax just for the privilege of doing business in California
However, new corporations do not have to pay the minimum franchise tax for its first year
Corporation Costs in California
Business License/Permits – check out http://www.calgold.ca.gov/ to know exactly what licenses and permits you need to obtain to conduct business in your particular city and county
Creating and Filing Articles of Incorporation
Creating the Bylaws (if hiring a business lawyer to draft them)
Shareholder Agreement (optional)
Filing Statement of Information
Franchise Tax of at least $800/year
Obtaining an Employer Identification Number (EIN)
Intellectual property protection, such as registering the business name as a trademark or registering any copyrights or patents your business may have
*The above article is for general informational purposes only and should not be taken as legal advice. Please contact a business lawyer to find out how any information here applies to your particular circumstances.