When a small company gets incorporated, it is actually a C corporation by default since it is also known as a regular corporation. The most fundamental aspect of this business is that it is lawfully observed as an individual entity, which means that it is separate from its owners, and these owners are basically the shareholders of the company.
So, when a corporation gets sued, the shareholders are responsible only to extent of their investment in it. This means the owner’s personal assets aren’t in any danger when the company gets sued, unlike in a sole proprietorship or a partnership.
Since the corporation is a separate entity for the law, it is also observed as an independent taxpayer by the IRS (Internal Revenue Service). And due to this, the corporations are usually subjected to double taxation. A business can select the S corporation status for avoiding the negative aspects of the C corporations, if eligible.
Below are the pros and cons of the C corporations to understand the system better.
Advantages of the C Corporation
Below are the main pros of the C Corporations due to which many choose to open this type of entity:
- Continuance of Existence: The death of an owner or the transfer of stock doesn’t change the corporation that exists unceasingly, regardless of the owners. This is only and until the company is dissolved. Even though this is taken as an advantage, some experts argue that in actuality, there is no need to incorporate a business to ensure that it would continue even after your death. The sole proprietor can easily transfer the company by utilizing the living trust or will for assigning the company to their heirs, or anyone they wish to. The partners usually have insurance-funded buy-sell negotiations that permit the outstanding associates to sustain the company.
- Fringe Benefits: A significant advantage that the C corps have over the S corps and the unincorporated companies are that they are allowed to deduct the fringe benefits from the taxes as a business expense. These benefits include the employee medical expenses that are not paid by insurance, death benefits payments to $5,000, disability and health insurance and group term life insurance.Along with this, the shareholder-employees are even excluded from paying any tax on the fringe benefits that they obtain. However, for the corporation to be qualified for this tax break, the owners should not have the business plan designed in such a way where only the shareholder and owners get the benefits. A large portion, usually 70% of the employees should also be able to obtain the advantage of the benefits. Moreover, for many small companies, providing the fringe benefits to all the employees costs the company too much, which is why the tax break might not be deemed an advantage.
- Drawing Top-Notch Employees: The corporations of this type find it very easy to attract and draw the industry’s best employees who are enticed by the fringe benefits and the stock options.
- Raising Capital: It is very easy for a C corporation to raise capital as compared to a sole proprietorship or partnership since a corporation has enough of stocks that can be sold. The investors can be tempted by the probability of dividends in case the company earns a profit. In short, this avoids the requirement of paying high-interest rates by seeking out loans so as to secure capital.
- Limited Liability: Many of the small companies that think of incorporating a C corporation do it for the limited liability. Due to sudden overwhelming debts or a lawsuit against the business, the life savings of the sole proprietor or partner would be jeopardized easily. And if the company is a C corporation, this fear disappears. Even though the shareholders are responsible for the amount that they invest in the C corporation, their personal assets would not be touched. Rather than purchasing the costly liability insurance, a lot of the small business owners decide to incorporate for protecting themselves.
Disadvantages of the C Corporation
Below are the main cons of the C Corporations due to which many fear to open this type of entity:
- Rules Governing Dividend Distribution: The profits of a corporation are divided by stock holdings, while in a partnership, the profits are divided by the employment or capital investment in the firm. In short, in case a stockholder has 10% of the stock of the corporation, he/she might only get 10% of the profits. However, if this person was in a partnership where he/she contributed 10% of the capital of the company, this person would be able to obtain more than 10% of the profits of the business, if the partners made such a negotiation. There are strict laws that rule the dividends of corporations. Mostly, every previous operation has to be paid for before the directors of the corporation declare a dividend. And if not done, the financial stability of the company can be put at risk by the dividends paid, where the directors can be held responsible to the creditors in many states.
- Bureaucracy & Expense: The corporations are administered by the federal and state laws, where at times they need to abide by complex corporate laws. Hence, the board of directors and stockholder meetings have to be held, where each minute has to be recorded. Along with this, tax preparers and lawyers have to be hired for these details. The directors have to approve all the actions of the corporations, and the companies would have to pay fees to the government, which vary in each state. In small court claims, they would have to hire a lawyer, unlike the partners or sole proprietors who can represent themselves. Also, if there is no business in the company, the corporation would still be subjected to pay the taxes in the state.
- Double Taxation: After all the deductions have been made on the business expenses, the C corporations pay profit taxes at the corporate level. And if the profits are distributed to the shareholders, they have to pay tax for it when they file the personal tax returns. This might not be a drawback for those who want to reinvest the profits into the business. Also, for many small companies, most (not all) profits are utilized to pay fringe benefits, and salaries that are deductible. And with this double taxation is avoided as well, when there is nothing left for distributing dividends.
So, if you are about to start a business, choose wisely depending on your needs and future plans for the business. IncParadise can help you incorporate your company after you have decided the structure and the type of entity that you want.