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C Corporations Offer Advantages - And Disadvantages

C Corporations Offer Advantages - And Disadvantages

After you form your corporation or LLC you have the opportunity to choose how it will be taxed for federal income tax purposes. The IRS starts out classifying every corporation as a C corporation—meaning the corporation pays taxes on its income. However, if the corporation meets certain requirements of the tax code, and the shareholders so desire, they can make a filing with the IRS to be classified as an S corporation instead. That way the corporation will not pay taxes. Instead, its income passes through to the shareholders who report and pay taxes on the business’ income on their personal return.

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

C corporations are generally considered to have the following advantages:

• Separate legal identity
• 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
• Ability to offer stock options
• Tax planning opportunities

CT Tip: It should be kept in mind that if the shareholders want to they can opt out of some of these advantages. For example, a corporation can provide in its articles of incorporation it will exist for a limited number of years, there can be agreements to restrict the transfer of shares, and the shareholders can agree to be responsible for the corporation’s debts.

A Corporation Is Separate from Its Owners

Once formed, a corporation has 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.

A Corporation Offers Owners Limited Liability Protection

Because a corporation is a separate entity, its debts, obligations, and liabilities are its own. Those who do business with a corporation must look to the company to satisfy any obligations owed to them, and not to the shareholders. The shareholders' exposure to loss is limited to the amount invested in the corporation.

A Corporation Has a Perpetual Existence

Not only does a corporation have a separate existence from its shareholders, 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. Unless its articles of incorporation provide otherwise, once a corporation is formed, it continues to exist until it is dissolved, wound up and liquidated. 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

Corporations are managed by a board of directors who appoint the officers who run the day to day operations. This is provided for in every state corporation law. 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. Shareholders do have management rights but they are limited to electing directors, removing directors under certain circumstances, voting on certain major structure changes, such as mergers or dissolution and inspecting certain books and records.

CT Tip: Some states have a statutory close corporation law which allows shareholders to manage without a board of directors, but this is a limited exception.

Free Transferability of Shares

A share of corporate stock provides both economic and management rights. A shareholder can freely sell those shares and the buyer will become the shareholder with all of those rights. A member in an LLC can sell his or her economic rights but not the management rights. Unless the operating agreement provides otherwise, the member has to get consent from other members to sell the whole interest and have the buyer become a member.

Easier to Attract Outside Investment

C corporations have an easier time attracting investors. Owning shares is generally considered preferable to owning LLC membership interests which is why a corporation can obtain capital through equity financing easier than an LLC. Also, venture capitalists prefer to invest in C corporations. And, in fact, many venture capitalists cannot invest in S corporations or LLCs because of restrictions in their own governing documents and the tax laws. In addition, companies planning an IPO generally prefer corporations to LLCs and cannot choose S corporation tax status because of the 100 shareholder limit. It may also be 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 governing documents provide otherwise, there are no restrictions on who can own stock in a C corporation. The tax laws restrict who can own stock in an S corporation. For example, individuals who are not US citizens or resident aliens cannot own stock in an S corporation. Corporations and LLCs cannot be S corporation shareholders either. There is also a 100 shareholder limit for S corporations.

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 management to better predict the legal consequences of their decisions and for investors to know the impact of changes in corporate structure, which permits them to draft 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. The tax implications of being a C corporation versus an S corporation or LLC should be discussed with a trusted tax adviser.

Operating as a Corporation Can Have Disadvantages

While there are benefits gained from C corporation status, there are some downsides as well. The two major disadvantages are:

• Complexity
• Double Taxation

Complexity

A corporation is more complex to operate than an LLC. The corporation laws require more formalities in how a corporation is managed. For example, shareholder and director meetings are required. Proper notice must be given and minutes kept. In contrast, LLCs can be managed more informally. Corporation laws also tend to have stricter record-keeping requirements. 

Double Taxation 

A corporation is a separate tax-paying entity unless it makes an election to be taxed as an S corporation. 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. The shareholders then pay personal income taxes on the dividends. This is the often mentioned “double taxation".  However, there are ways to reduce or eliminate double taxation that a tax adviser can recommend.

Conclusion

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.

Learn More

Learn more about how CT can help you select the incorporation type that best suits your company's needs. 

 

Information in this article has been updated for 2018; it was originally published on September 9, 2014.

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