When it comes to starting a business, people generally hear about two types of business formation, LLCs and Corporations. Some make the mistake of lumping the two together as synonyms when they are two distinct entities, each with their own pros and cons. We are going to break down what a Corporation is, how to start a Corporation, the benefits of a Corporation, the negatives of a Corporation, how Corporations are taxed, and who a Corporation fits best.
If you’re interested in learning about LLCs as well, please visit our article “What is an LLC” where we go into detail about LLCs in the same way.
Please also be aware that “incorporating” is another way to describe starting a Corporation. Incorporating and starting a Corporation can be used interchangeably.
What is a Corporation?
A Corporation is a business entity type, like an LLC. Some of the biggest companies in the country are Corporations, and that is often what is associated with Corporations. The truth is a Corporation doesn’t have to be a large multinational company, because there are benefits for smaller businesses as well.
First, let’s breakdown what a business entity is so that you can further understand what a Corporation is. A business is a completely new being in the eyes of the government. This being is owned and operated by you and whoever else may own stake in the company. But this being also has its own set of assets, rights, and responsibilities. The entity also removes owners from direct liability, which we will explain in the benefits section.
When it comes to Corporations, there are two types. First is a C-Corporation. C-Corporations are the standard form of Corporations. This type of Corporation is very popular with investors and can be publicly traded. However, C-Corporations are double taxed, which we will dive further into the tax section.
The other type of Corporation is an S-Corporation. An S-Corporation is actually a tax elective of a regular Corporation. An S election means that S-Corporations are taxed like an LLC, meaning that only the owners are only taxed on profits they receive as dividends. However an S-Corporation does have drawbacks, including stricter regulations on ownership and stock options.
It’s also important to note that an owner of a Corporation can be known as a Shareholder.
How Do I Incorporate?
When forming a Corporation, each state requires slightly different specifications so this will be a general formation guide. The first step will always be to compile Articles of Incorporation. Here’s what the Articles of Incorporation may need to include:
Business Address (which can be your own address if you don’t have a dedicated space yet)
Filer’s Information (also known as the Organizer)
Purpose of the Business
Once the Articles of Incorporation have been filed with the state, you will be given an EIN, which can be likened to the business version of a Social Security Number. EIN is short for Employer Identification Number. With the EIN and approved Articles of Incorporation, you can open a business bank account with most banks.
The next step varies state by state but we can’t recommend it highly enough. A majority of states require Corporations to have a set of Bylaws, which outline the business’ structure, governance, and company rules. Every Corporation should have a set of written and signed set of bylaws. Here are the states where this is a requirement:
District of Columbia (DC)
If you are opting for an S-Corporation, you must file Form 2553 with the IRS, signed by all shareholders. This process will take slightly longer to complete but once the IRS approves, your S-Corporation will be set up properly.
After all of this, your Corporation should be ready to run. Please keep in mind that Corporations do have several yearly requirements that vary state-to-state. If you have any questions about the start-up process for Corporations or how to stay legally compliant, you can contact our office for a free consultation with a business attorney. Contact us to have an attorney call you or you can call us directly at 212-256-1877.
The Benefits of a Corporation (Pros)
There are benefits to a Corporation that makes them desirable to companies in certain fields and those looking to grow their business quickly. It’s also important to note that some people prefer the corporate structure. This means that there are clear checks and balances. The founders and shareholders appoint a Board of Directors, who then appoint Corporate Officers to run the company. The Corporate Officers can then manage the company under the oversight of both shareholders and the Board. A Corporation must also keep Corporate Minutes and hold Annual Meetings to keep everyone informed.
The other big boon that a Corporation, whether C or S, offers is the Limited Liability Protection. This means that the owners are kept separate from the company in case of any lawsuit or debt. Should a company be collected on, owners’ personal assets can’t be touched. If the Corporation accrues too much debt or closes with any outstanding balances, the owners aren’t liable for any of it, barring gross negligence.
Forming a Corporation also secures a business name on a state level, meaning no other company may use that name. Corporations also provide a level of gravitas and authority that Sole Proprietorships and even LLCs don’t. If you want to learn more about branding, read about “How to brand my business”.
C-Corporations C-Corporations offer the most flexibility for companies looking to gain investors, be traded publicly, and freely move stock. Corporate law is well established in the United States as opposed to LLCs and S-Corporations which are subject to changing regional laws and regulations.
Corporations can easily offer stock options as well as be traded publicly, leading to nearly limitless growth potential. This is why investors will always prefer a C-Corporation, so they can be easily and adequately compensated for their contributions. C-Corporations also have a lot of options when it comes to tax deductions and maneuvers to mitigate the pain of double taxation.
S-Corporations S-Corporations are largely popular because of the pass-through taxation they offer. S-Corporations are often described as a hybrid of an LLC and a Corporation, because they offer the taxation of an LLC with the structure of an LLC. S-Corporations still have Corporate Officers and a Board of Directors but an S-Corporation is not taxed at the business level.
The Negatives of a Corporation (Cons)
The big negative new businesses often point to, is the rigid structure and regulation surrounding Corporations. Because Corporations require Corporate Officers, Corporate Minutes, Annual Meetings, and a Board of Directors, small businesses often opt for an LLC instead.
C-Corporations C-Corporations are double-taxed, which means the business pays taxes on any profit it receives and then shareholders are taxed on any profit they receive from dividends. There are ways to mitigate these taxes but at the end of the day, paying taxes twice is never anyone’s preferred choice.
S-Corporations Although S-Corporations don’t have to deal with double-taxation, they are heavily restricted. S-Corporations can’t have more than 100 shareholders, can’t be owned by any other Corporations, LLC, or most trusts. The shareholders must also be US citizens. An S-Corporation also can only issue one kind of stock, as opposed to a C-Corporation.
How is a Corporation Taxed?
As previously mentioned, taxes are tricky with Corporations, which is why we always recommend speaking to an accountant about what works best for your business model.
C-Corporations As previously mentioned, C-Corporations are double taxed, so the business pays taxes as well as the shareholders. A savvy accountant can help with deferring certain taxes but taxes are inevitable in some capacities.
S-Corporations S-Corporations are taxed like an LLC, meaning that profits and losses are passed directly to the shareholders. The S-Corporation itself doesn’t pay any taxes.
Who is a Corporation for?
Starting a Corporation is not for every business and works best for specific goals and industries. A C-Corporation is best for those that are looking to work across the country, as well as internationally. If you’re looking to gain investors or be publicly traded, then a C-Corporation is the right choice for you. We also recommend a C-Corporation for businesses in the tech field.
S-Corporations are best for those who like the firm structure of a Corporation but want the tax benefits of an LLC. S-Corporations aren’t necessarily built for growth like a C-Corporation but are a perfect middle ground between C-Corporations and LLCs.
If you are interested in starting your own Corporation or have more questions about what business entity works best for you, we offer free consultations. You can contact us to receive a callback from a business attorney or you can call us right away at 212-256-1877.