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C Corporations Offer Advantages - And Disadvantages

The C Corporation is an often overlooked option for the small business owner, who think first of an LLC or an S corporation. True, there is the possibility of double taxation and more state compliance requirements, but these drawbacks are often overstated. And, choosing to operate as a C corporate can offer many advantages that other business types, such as the LLC or S corporation, do not. This article explores some of the benefits that a C corporation can offer to its owners.

A C corporation is created by filing Articles of Incorporation with a state. The laws of the incorporation state govern the operations of the corporation. For this reason, many companies that are interested in expansion, venture capital funding, or going public incorporate in a business-friendly state, such as Delaware or Nevada. These business-friendly states tend to have fewer regulations regarding internal governance and public disclosure of information.

Regardless of its incorporation state, C corporations have the following advantages:

  • Separate legal identity
  • Asset protection (limited liability for the owners)
  • Perpetual existence
  • Separation between ownership and management
  • No restrictions on who can hold shares
  • Readily transferable shares
  • Well-established legal precedents
  • Widespread acceptance by the venture capitalists and other investors
  • Tax planning opportunities, including restructuring options and tax-free gain from shares of qualified small business stock.

While limited liability companies (LLCs) and S corporations share the first three advantages, only the C corporation offers all of them. 

A Corporation Is Separate from Its Owners

Once formed, a corporation as a life of its own, with its own rights, capabilities, responsibilities and liabilities. This means that a corporation can sue (or be sued) in its own name. It can buy, own, and use its own real or personal property, make its own contracts and guarantees, lend money and invest funds. This leads to the second advantage that incorporating can bring: asset protection.

A Corporation Offers Owners Limited Liability Protection

Because a corporation is a separate entity, the owners of the company have limited liability. Those who do business with a corporation must look to the company to satisfy any obligations owed to them, and not to the shareholders. This means that the corporation’s creditors cannot reach the assets of the shareholders to satisfy the company’s debts and obligations. The shareholders exposure to loss is limited to the amount invested in the corporation.

CT Tip: Be forewarned: ­Limited liability is not absolute. If a shareholder guarantees the obligations of the business or co-signs a loan, then the shareholder’s assets are at risk. Also, it’s possible for a court to disregard the corporation’s existence using a doctrine referred to as “piercing the corporate veil.” If this happens, creditors can reach the owner’s assets. In most cases, this occurs when the shareholder(s) completely dominated the company and did not treat it as a separate entity or used the corporation to perpetrate wrong or injustice.

A Corporation Has a Perpetual Existence

Not only does a corporation have a separate existence from its shareholders, by default, it has a perpetual existence. If the owner of a sole proprietorship dies, the business ceases to exist. This isn’t the case with a corporation. Under the default rules in all states, once a corporation is formed, it continues to exist until it is dissolved by the owners or the state. What’s more, the transfer of shares of stock has no impact on the existence of the corporation. 

Shareholders Do Not Directly Manage the Corporation

One of the advantages of operating as a corporation is that stock ownership is divorced from corporate management. A shareholder is entitled to economic benefits based upon number and types of shares owned, but the shareholder does not have the right to manage the day-to-day affairs of the corporation. Unless the corporation is operating as a close corporation, the shareholders' management functions are limited to electing directors and voting on certain major structure changes, such as mergers or dissolution.

CT Tip: Operating as a "close corporation" can permit corporations with relatively few shareholders to dispense with many of the corporate governance rules and formalities. If the corporation is organized as a close corporation, the shareholders can govern directly and many of the notice and recordkeeping requirements are eliminated. Not all states permit this corporate form and the requirements vary among states that do allow it so competent advice is required prior to incorporation.

In addition, shares of stock can be freely transferred from shareholder to shareholder—unless a buy-sell agreement is in place.

CT Tip: The free transferability of shares can sometimes put a company at risk. How? A shareholder’s personal creditors can attach and assume all rights to the shareholder’s stock. If the shareholder has a controlling interest in the corporation, the creditors will have the power to elect directors that will do their bidding or to force a vote to dissolve the corporation. An attorney can advise on how to structure buy-sell agreements and craft share restrictions that can prevent this outcome.

Because of the split between ownership (economic rights) and management (control), corporations have a much easier time attracting passive investors through equity offerings, including public offerings.  This is why venture capitalists prefer to invest in corporations—and why companies that are seeking venture capital often incorporate. It is also far easier for a corporation to offer stock options—a key way to attract talent to the business. It is also generally easier for a corporation to obtain bank financing. This factor can be especially important in capital intensive businesses

No Restrictions Are Placed on Shareholders

Unless the corporation's bylaws provide otherwise, there are no restrictions on owning C corporation stock. Unlike S corporations, there are no limits placed on the number of shareholders or the types of shareholders in a C corporation. Foreign corporations, non-resident aliens and most other individual and entity types cannot be S corporation shareholders, but can hold shares in a C corporation. There cannot be more than 100 S corporation shareholders, but the number of shareholders in a C corporation unlimited. This is another reason why founders who wish to grow rapidly, seek overseas investment or go public will opt for a C corporation over the more restricted S corporation and possibility unwieldy limited liability company (LLC).

Corporate Law Is Well-Established

Operating as the oldest type of formal entity can be an advantage because there are few surprises left in corporate law. While states struggle to establish what corporate precedents transfer to the LLC, most of the essentials that apply to corporations are well-established. This makes it possible for investors to know the impact of changes in corporate structure and permits them to draft valid agreements to protect themselves. 

Corporations Provide Multiple Tax Planning Opportunities

Operating as a corporation may involve additional complexity, but it also provides a wide array of tax planning opportunities across the business life cycle.

  • Starting up: Small businesses that operate as C corporations may be able to offer "Qualified Small Business Stock." If this stock is held for at least five years, all gain upon its sale is completely tax-free. S corporation shares and LLC membership interests cannot qualify for this tax-free gain. 
  • Operating the business: S corporations and LLCs that have not elected to be taxed as a corporation are pass-through tax entities. This is often touted as an advantage of the C corporation, which is a separate taxpaying entity. However, pass-through taxation means that all the corporation's profits are deemed distributed to the owners in the year they are earned—even if those funds are actually sitting in a business bank account to fund future expansion. C corporations are not required to distribute all of their earnings and the shareholder pays tax only on what is actually distributed. In addition, C corporations can structure compensation to reduce the overall tax liability of owner-employees. (S corporations can also take advantage of this strategy.)
  • Winding down: There are many reorganization and termination options available to C corporations that can result in lower tax liabilities for shareholders. This flexibility is particularly valuable when the business plan calls for acquisition down the road. 

Operating as a Corporation Can Have Disadvantages

While there are many benefits gained from C corporation status, there are some downsides as well. However, careful planning can greatly reduce most of these concerns. Two major disadvantages are

  • Complexity
  • Taxation

As noted earlier, a C corporation is more complex to operate than an LLC because of the corporate formalities and record-keeping requirements. However, operating as a close corporation (in a state that allows this structure) is one way to greatly reduce the impact of formalities and record-keeping. If operating as a close corporation is not possible or is not desirable, then purchasing a good quality corporate record book and consulting an attorney familiar with your state’s laws can demystify and streamline your compliance obligations.

Double Taxation Can Be Minimized

A corporation is a separate tax-paying entity unless it makes an election to be taxed as an S corporation. (See our article, “How to Make an S Corporation Election” for more information.) This means a C corporation pays corporate income tax on its income, after offsetting income with losses, deductions. and credits.  A corporation pays its shareholders dividends from its after-tax income. This is the often mentioned “double taxation.” However, there are many ways to reduce or eliminate double taxation. Among the more common strategies are:

  • paying salaries to owner-employees
  • making contributions to deferred compensation plans or
  • retaining earnings within the corporation

Our article, “How Are C Corporations Taxed” provides additional information on corporate taxation for C corporations.

As you can see, there are advantages and disadvantages to operating as a C corporation.  Your accountant and attorney can help you evaluate whether this is a good fit for your business and your growth plans.

Information in this article has been updated for 2016 and includes mention of the now permanent exclusion of gain from the sale of qualified small business stock. This article was initially published on September 9, 2014.

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