Advantages and Disadvantages of a Corporation
ADVANTAGES OF A CORPORATION
Personal Liability Protection:
Your personal assets are protected from claims brought against the corporation. This is the primary reason for incorporating.
This means, if the corporation is sued or you go out of business and still owe your suppliers and other creditors money, or if the corporation is sued, your personal assets will be insulated from claim brought against the corporation.
Having the ability to issue stock offers you an opportunity to raise a larger amount of capital than is normally possible from family, friends, and relatives.
Issuing stock gives you a vehicle, namely stock certificates, for raising capital from a greater number of potential investors with various amounts of money to invest than just those individuals in your immediate circle.
For example, if you need to raise $100,000 and your family, friends, and relatives can only come up with $20,000, you could offer 200 shares of stock for $100 per share to them and 800 shares to other investors.
The number of investors you'll need depends on how much each investor can afford.
However, by being able to offer shares of stock for only $100 per share allows for a wider range of investor participation.
CAUTION! If you want to retain control of your corporation you need to own at least 51% of all the voting stock.
Transferability of Ownership:
In the absence of any valid restrictions on the transfer of corporate stock, a shareholder may transfer his shares to anyone.
The corporation can require that existing shareholders, or the corporation itself, have the right to purchase the stock first. This may be done to keep strangers out.
Continuity of Life:
If a shareholder transfers or sells his shares, or dies, the corporation still legally exists. The corporate entity may continue doing business as usual.
The Dividends-Received Deduction:
If your corporation invests in the stock of other domestic C corporations and they pay a dividend, your corporation may exclude 70% of the dividend from taxes.
If your corporation owns more than 20% of the stock of a domestic C corporation which pays a dividend, 80% of the dividend may be excluded from taxes.
Employees of a C corporation may get certain tax-free benefits not available to sole proprietors, partners, LLC members, and shareholders of an S corporation owing more than 2% of the stock in the corporation.
This allows a corporation to be more competitive in attracting higher caliber employees.
Some benefits include:
- Employer-provided group term life insurance
- Health insurance coverage
- Medical reimbursement plans
- Dependent care assistance
- Education assistance
- Adoption assistance
DISADVANTAGES OF A CORPORATION
Setting up a corporation may cost hundreds or even thousands of dollars in legal, accounting, and filing fees. Then there are the ongoing legal and accounting fees to comply with state corporation laws and federal and state tax laws.
A C corporation is NOT a pass-through entity. Consequently, corporate net income may be taxed twice:
- First, at the corporate level
- Then again, at the individual level when the income is distributed to the shareholder as a dividend.
C corporation Losses Not Deductible By Shareholders:
C corporation net losses are not deductible by shareholders on their individual income tax return. Net losses are deducted by the C corporation against its net income of other periods.
Accumulated Earnings Tax:
A corporation may be subject to the accumulated earnings tax. The tax is 15% of earnings that exceed the exemption amount. For C corporations the exemption amount is $250,000 or less. For personal service corporations (PSC) the exemption amount is $150,000 or less.
However, even if the exemption amounts are exceeded, regardless by how much, if earnings are being accumulated for what the IRS considers to be for the reasonable needs of the business, the penalty tax won't be imposed.
For Freelancers and independent Contractors
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Have an accounting or bookkeeping question? Email it to me.
- Return to the Tax Basics for Startups Table of Contents to find related links.