Learn It 7.3.1: Corporations

  • Understand the differences between C and S corporations
  • Understand what a benefit corporation is
  • Understand the advantages and disadvantages of corporations
  • Understand the advantages and disadvantages of a limited liability company (LLC)

Corporations

When people think of corporations, they typically think of large, well-known companies such as Apple, Netflix, Nike, and General Electric. But corporations range in size from large multinationals with thousands of employees and billions of dollars in sales to small firms with few employees and revenues under $25,000. While corporations are not the most common form of business ownership, they do account for the majority of the revenue from businesses in the United States.

In this section you’ll learn about C and S corporations, and, a newcomer to the corporate scene, the benefit corporation.

Corporation (C Corporation)

corporation (C corp)

A corporation (sometimes referred to as a C corporation or C corp) is an independent legal entity owned by shareholders. This means that the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts of the business. This type of general corporation is called a C corp because Subchapter C of Chapter 1 of the Internal Revenue Code is where you find general tax rules affecting corporations and their shareholders.

Corporations are more complex than other business structures because they tend to have costly administrative fees and complex tax and legal requirements. Because of these issues, corporations are generally suggested for established, larger companies with multiple employees. Corporations offer the ability to sell ownership shares in the business through stock offerings. “Going public” through an initial public offering (IPO) is a major selling point in attracting investment capital and high-quality employees.

Forming a Corporation

A corporation is formed under the laws of the state in which it is registered. Because corporations are recognized as entities separate from their owners, the process is much more complex than establishing a sole proprietorship or partnership. The corporation must be “formed” and then recognized by the state’s Secretary of State office and/or State Corporation Commission. The way that corporations are “born” is through the filing of articles of incorporation with the state’s Secretary of State office.

Some states require corporations to establish directors and issue stock certificates to initial shareholders in the registration process. For this reason, establishing a C corporation can be expensive. Attorneys are often hired to draft the initial articles of incorporation, shareholders agreements, stock option agreements, and other related documentation. Filing the articles of incorporation, establishing a registered agent, and issuing stock are also tasks that attorneys often perform on behalf of those forming the corporation. 

As with other forms of ownership, once the corporation is formed, you must obtain business licenses and permits. Regulations vary by industry, state, and locality. If you are hiring employees, you will need to understand and follow federal and state regulations for employers.

Corporate Taxes

When you form a corporation, you create a separate tax-paying entity. Unlike sole proprietors and partnerships, corporations pay income tax on their profits. In some cases, corporations are taxed twice: first, when the company makes a profit, and again when dividends are paid to shareholders. These dividends appear on the shareholder’s personal tax returns and are subject to taxation.

It is important to note that only income paid as dividends is taxed twice. Income distributed as salary or other compensation is a deduction for the corporation. This means that the amount of compensation paid is deducted from the amount of corporate income that is subject to taxation. 

Just like individuals, corporations are required to pay federal, state, and in some cases, local taxes. Instead of supplying a social security number for taxpayer identification, corporations must register with the IRS and state and local revenue agencies, and obtain a tax ID number.

Advantages of a Corporation

  • Limited Liability. When it comes to taking responsibility for business debts and actions of a corporation, shareholders’ personal assets are protected. Shareholders can generally only be held accountable for their investment in stock of the company.
  • Ability to Generate Capital. Corporations have an advantage when it comes to raising capital for their business—the ability to raise funds through the sale of stock.
  • Corporate Tax Treatment. Corporations file taxes separately from their owners. Owners of a corporation only pay taxes on corporate profits paid to them in the form of salaries, bonuses, and dividends, while any additional profits are awarded a corporate tax rate, which is usually lower than a personal income tax rate.
  • Attractive to Potential Employees. Corporations are generally able to attract and hire high-quality and motivated employees, because they offer competitive benefits and the potential for partial ownership through stock options.

Disadvantages of a Corporation

  • Time and Money. Corporations are costly and time-consuming ventures to start and operate. Incorporating requires start-up, operating, and tax costs that most other structures do not require.
  • Double Taxing. In some cases, corporations are taxed twice—first, when the company makes a profit, and again when dividends are paid to shareholders.
  • Additional Paperwork. Because corporations are highly regulated by federal, state, and in some cases local agencies, there are increased paperwork and record-keeping burdens associated with this entity.