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Advantages and Disadvantages of Forming Your Business as a Corporation

When you start a new business, choosing the proper structure is a crucial early decision. Your business structure can affect things like the company’s taxes, your personal liability and how you must operate your business. One standard option is a corporation, but it may not be the right option for all businesses. Learn about the advantages and disadvantages of a corporation structure for your business to determine if it’s right for your organization.

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What is a corporation?

When you form a corporation, you create a legal entity separate from the owners, who are called shareholders. Corporations typically have a board of directors to make decisions, and the shareholders elect these directors. A corporation is more formal than some other business structures and affords the owners less personal liability. However, a corporation can be more expensive and complicated to run because of the reporting and record-keeping requirements and processes the business must follow.

A corporation can be formed by an individual, a group of people or even by another corporation.

Advantages and disadvantages of corporation business structure

Looking at the pros and cons of a corporation can help you decide if it’s the best business structure for you. Here are the major advantages and disadvantages of a corporation to consider.

Advantages of a corporation business structure

Some benefits of forming your business as a corporation are:

  • Limited liability for shareholders. Shareholders are usually only financially liable for the amount of their investments, which protects their personal assets. If your company faces a lawsuit, you’re not personally responsible as a shareholder.
  • Ability to raise funds. Publicly held corporations can sell shares and issue bonds to raise funds for the business. This can be much easier and faster than traditional business funding methods.
  • No life limit. Corporations have a perpetual life since ownership can pass through generations of investors. This means the business continues to operate as usual even after the initial founder has passed.
  • Easy ownership transfer. While there are some limitations, transferring ownership is relatively easy through buying or selling shares. That means it’s often much easier for an owner to leave the company.
  • Tax-deductible expenses. Owners may receive tax-free benefits, including retirement plans and insurance, and the corporation can deduct employee and officer benefits.
  • Attractive to investors and employees. Offering stocks can be enticing if you want to attract more investors. You can also offer stocks to your employees as part of your benefits package.
  • Clear structure. Because of the organizational requirements for formation, corporations have a clear hierarchy that can make operations more straightforward. The responsibilities at each level within the organization are also clearly defined.

Disadvantages of a corporation business structure

Here are some disadvantages to forming your business as a corporation:

  • A corporation is a distinct legal entity. The business is governed by a board of directors. A different structure may suit you better if you want to maintain full control of your business.
  • Double-taxation. Corporations pay taxes on profits distributed to shareholders. Then, shareholders pay taxes on their shares. Although it isn’t technically double taxation for the owner, it may be less appealing.
  • More complicated to form. Corporations require more initial documents and filing fees such as tax-exemption paperwork, incorporation documents, state filing fees, attorney fees, and annual documents and fees.
  • More requirements. Once you form your corporation, you have ongoing requirements that can be time-consuming. Corporations are required to have annual meetings and follow the established bylaws. You also have to create specific reports and maintain board meeting minutes.
  • Higher costs. Corporations typically require more capital to form and can be more expensive to operate over time. Other business structures are usually cheaper to start and run.

Creating a corporation

If you decide a corporation is the best option for your business, you can form the structure yourself, use a formation service or hire a lawyer. Each state sets specific requirements and processes to form a corporation, so check with your state to avoid delays.

Follow these general steps to form a corporation if you want to do it yourself.

1. Choose your business name

Include designation words such as “Limited,” “Incorporated,” “Corporation” or abbreviated versions in your corporation name. Check with your state’s business formation agency for a list of restricted words such as “national” or “reserve” to ensure your name complies with all other rules.

2. Make sure your name is available

Check with your state’s agency about your business name’s availability to ensure you don’t violate another company’s trademark. In most cases, you register the business name when you file the articles of incorporation, but with a fee, you can reserve it for a short period until then.

3. Register a “doing business as” name

If you intend to do business under a separate name from your corporate name, register a doing business as (DBA) name, also called a fictitious name, assumed name or trade name. DBA rules may differ at the state, county and city levels.

4. Appoint your directors and registered agent

Appoint a director from among other people. Each state has laws about how many directors you need. A registered agent is the contact person for your company who will receive government notices and compliance-related documents. An owner can be the registered agent, but they don’t have to be an owner.

5. File articles of incorporation

Your articles of incorporation include key details about your business, such as the name, purpose and information about the shares of stock that will be issued. Some states call this the certificate of incorporation or certificate of formation. Contact your Secretary of State’s office for the right incorporation paperwork to fill out and file.

6. Write your corporate bylaws

Corporate bylaws are rules governing how your corporation operates and include information about stocks, meeting procedures, record-keeping procedures and other business-related processes. Consult an attorney while drafting your corporate bylaws to ensure they meet all requirements.

7. Write your shareholder’s agreement

The shareholder’s agreement is optional but protects the interests of shareholders if an owner passes or leaves the corporation and transfers ownership. Draft this with a professional.

8. Hold your first board of directors meeting

In the first meeting, discuss the overall operations of the corporation, including bylaws, appointing of corporate officers and authorizing the issuing of stock.

9. Issue your stock

Large corporations must register stock offerings with the SEC and their state’s securities agency. Depending on the size of your business, you may need to fulfill the requirements of the Securities and Exchange Commission (SEC).

10. Obtain business licenses and permits

Contact your local and state governments to determine which business permits and licenses you need before you officially begin operation. These requirements can vary depending on what type of business you start.

11. Register with state and local agencies and the IRS

You must register your corporation with both the IRS and state and local revenue agencies. Refer to the IRS website for more detailed information.

12. Open a corporate bank account

Your corporation must have a bank account separate from the owners’ personal accounts for tax compliance purposes — research different banks for the best account options.

Related: 10 Steps to Starting a Business

Frequently asked questions about the advantages and disadvantages of a corporation as a business structure

Below are some of the most commonly asked questions about corporations.

What is the difference between a C corporation and an S corporation?

All corporations begin as a C corporation but can change to an S corporation by filling out additional paperwork. S corporations aren’t subject to double taxation. Instead, business income is taxed at the personal tax rates of the owners rather than at the corporate level. However, S corporations may only have one class of stock and a maximum of 100 shareholders, all of whom must be U.S. citizens.

Can one person form a corporation?

Anyone can form a corporation, even another corporation. All states allow corporations to have a single owner. However, it still must follow all the normal formalities to keep the corporation in compliance with state and federal laws.

Does a corporation have to be formed in the state of operation?

You can form a corporation in any state outside the one you do business in. If you file in a more tax-friendly state, such as Nevada or Delaware, but intend to do business in your home state, you must also file documents in your state. Through this “foreign qualification” process, you can do business in multiple states.

How do you decide if a corporation is the right structure for your business?

Weighing the advantages and disadvantages of a corporate structure may help you decide if it’s the option you want to pursue. However, considering a general list of advantages and disadvantages of a corporate structure doesn’t give you a personalized look at how the structure can impact your business. If you’re unsure, it’s best to talk to a professional who can help you decide. Business lawyers can examine your situation and explain how each structure type will affect your organization. They can also help you form whatever kind of business structure you choose. Tax advisors or accountants can also help you select an entity type that gives you the best tax advantages.

How can corporations reduce their taxes?

There are a few ways in which a corporation can reduce the taxes they owe to the IRS. The most common methods to reduce a corporation’s taxable income are through net operating losses, tax credits, accelerated depreciation and profit sharing. Corporations should always use a professional accountant to file their taxes to ensure they do so correctly and take advantage of all possible tax breaks.

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