Talk to an accountant if you are unsure which organizational business structure you should choose.

What are the different types of corporations? Should you form an LLC instead? Learn the corporation advantages and disadvantages of a C corporation,

an S corporation, and an LLC.

 

Types of Corporations

Anyone who operates a business, alone or with others, may incorporate. This is also true for anyone or any group engaged in religious, civil, non-profit or charitable endeavors. You do not have to be a business giant to be able to have the financial and other benefits of operating a corporation. Given the right circumstances, the owner(s) of a business of any size can benefit from incorporating.

There are different types of corporations. Here are the pros and cons of each type of business structure to help you decide which one is right for you.

This is the most common corporate structure. The corporation is a separate legal entity that is owned by stockholders. A general corporation may have an unlimited number of stockholders that, due to the separate legal nature of the corporation, are protected from the creditors of the business. A stockholder’s personal liability is usually limited to the amount of investment in the corporation and no more.

Corporation Advantages

  • Owners’ personal assets are protected from business debt and liability

  • Corporations have unlimited life extending beyond the illness or death of the owners

  • Tax free benefits such as insurance, travel, and retirement plan deductions

  • Transfer of ownership facilitated by sale of stock

  • Change of ownership need not affect management

  • Easier to raise capital through sale of stocks and bonds

 

Corporation Disadvantages

  • More expensive to form than proprietorship or partnerships

  • More legal formality

  • More state and federal rules and regulations

Close Corporation

There are a few minor, but significant, differences between general corporations and close corporations. In most states where they are recognized, close corporations are limited to 30 to 50 stockholders. In addition, many close corporation statutes require that the directors of a close corporation must first offer the shares to existing stockholders before selling to new shareholders.

This type of corporation is particularly well suited for a group of individuals who will own the corporation with some members actively involved in the management and other members only involved on a limited or indirect level.

S Corporation

With the Tax Reform Act of 1986, the S Corporation became a highly desirable entity for corporate tax purposes. An S Corporation is not really a different type of corporation. It is a special tax designation applied for and granted by the IRS to corporations that have already been formed. Many entrepreneurs and small business owners are partial to the S Corporation because it combines many of the advantages of a sole proprietorship, partnership and the corporate forms of business structure.

S Corporations have the same basic advantages and disadvantages of general or close corporation with the added benefit of the S Corporation special tax provisions. When a standard corporation (general, close or professional) makes a profit, it pays a federal corporate income tax on the profit. If the company declares a dividend, the shareholders must report the dividend as personal income and pay more taxes.

S Corporations avoid this “double taxation” (once at the corporate level and again at the personal level) because all income or loss is reported only once on the personal tax returns of the shareholders. However, like standard corporations (and unlike some partnerships), the S Corporation shareholders are exempt from personal liability for business debt.

S Corporation Restrictions

To elect S Corporation status, your corporation must meet specific guidelines. As a result of the 1996 Tax Law, which became effective January 1, 1997, many of these qualifying guidelines have been changed. A few of these changes are noted below:

  • Prior to the 1996 Tax Law, the maximum number of shareholders was 35. The maximum number of shareholders for an S Corporation has been increased to 75.

  • Previously, S Corporation ownership was limited to individuals, estates, and certain trusts. Under the new law, stock of an S Corporation may be held by a new “electing small business trust.” All beneficiaries of the trust must be individuals or estates, except that charitable organizations may hold limited interests. Interests in the trust must be acquired by gift or bequest — not by purchase. Each potential current beneficiary of the trust is counted towards the 75 shareholder limit on S Corporation shareholders.

  • S Corporations are now allowed to own 80 percent or more of the stock of a regular C corporation, which may elect to file a consolidated return with other affiliated regular C corporations. The S Corporation itself may not join in that election. In addition, an S Corporation is now allowed to own a “qualified subchapter S subsidiary.” The parent S Corporation must own 100 percent of the stock of the subsidiary.

  • Qualified retirement plans or Section 501(c)(3) charitable organizations may now be shareholders in S Corporations.

  • All S Corporations must have shareholders who are citizens or residents of the United States. Nonresident aliens cannot be shareholders.

  • S Corporations may only issue one class of stock.

  • No more than 25 percent of the gross corporate income may be derived from passive income.

  • An S Corporation can generally provide employee benefits and deferred compensation plans.

  • S Corporations eliminate the problems faced by standard corporations whose shareholder-employees might be subject to IRS claims of excessive compensation.

  • Not all domestic general business corporations are eligible for S Corporation status. These exclusions include:

    • A financial institution that is a bank;

    • An insurance company taxed under Subchapter L;

    • A Domestic International Sales Corporation (DISC); or

    • Certain affiliated groups of corporations.

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