A corporation is a group of people or a company authorized to act as a single entity. It receives recognition under the law to operate legally for specific purposes through registration with local governments and the establishment of articles that declare intent.
Several different corporation structures are available today. Most are chartered based on whether or not they can issue stock or make profits. They can be a corporation sole owner or have an aggregate of owners through the use of equity ownership. The two most common options you’ll find in the United States are C-corporations and S-corporations, but certified B-corporations are a choice in 35 states and the District of Columbia as of 2019.
Another option is the “close corporation” in some states that takes an S-corp form, but places additional restrictions on its structure.
As far as American law is concerned, corporations have many of the same legal rights and responsibilities as individuals. Anyone can sue a corporation, but the company can instigate litigation against owners. They can own property, exercise human rights against people or the state, and be subject to human rights violations. It is even possible to convict one of criminal offenses.
Several pros and cons of corporations are worth reviewing if you find yourself in a position to start a business shortly.
List of the Pros of Corporations
1. Corporation owners receive legal liability protections.
Once a business owner successfully completes the incorporation process, then the owner has a limited level of legal liability to the company’s activities and debts. This advantage is due to the law’s perspective that the organization is a separate entity. Owners must follow some specific formalities to continue receiving this advantage, including complete separation of personal and business accounting.
In exchange for maintaining a separate identity, the personal assets of the owner(s) cannot be targeted by litigation. Only the assets of the company are at risk during litigation.
2. Some corporations can attract investors.
S-corporations have limitations on the number of shareholders that it can manage, but that restriction goes away under the C-corp structure. That gives a business the opportunity to present a strong selling point to people who may want to invest capital into the venture. Each person or another corporation can purchase stock based on equity so that any profits from the organization can be distributed as dividends.
This advantage allows for investors to earn returns while the corporation works on growing new opportunities.
3. Corporations can attract more financing options for owners.
If you want to form a business, then a C-corporation structure offers the most opportunities for future financing. Investors don’t like to get involved with sole proprietors, partnerships, or limited liability companies because of the pass-through nature of the profits. Taking the time to incorporate suggests that the products or services are legitimate and ready to provide a return over time.
Investors don’t need to get involved with the daily operations of the business to earn a return from their activities. Owning shares can result in equity increases and dividend payments that allow for profits.
4. A corporation can last indefinitely.
If a business operates as a partnership, sole proprietorship, or LLC, then it might need to dissolve if one of the initial members leaves or passes away. The corporate structure is indefinite by comparison because of its status as an independent entity. That means it can continue to exist even if all of its original members or owners are gone.
The oldest continually operating company in the world today is Kongo Gumi, which established itself in the late 6th century. It is a construction company that remained family-run for over 1,400 years until it became a Takamatsu subsidiary. It specializes in the building of Buddhist temples.
5. Shareholders don’t need to be involved in business operations.
If a business operates as a C-corp, then the officers of the company are responsible for the daily operations. Shareholders in this structure have an entitlement to their equity percentage of ownership for voting, dividend distribution, and similar rights in this area. Incorporation creates clearly-defined roles for every member of the leadership team to follow, including the areas of responsibility for the Board of Directors.
You can own shares of a business without being part of the decision-making process. This structure helps to make the company operate as efficiently as possible.
6. Consumers have more confidence when working with a corporation.
Consumers want value in the products and services they purchase. The lowest cost does not always define this advantage. Other business structures, including sole proprietorships and partnerships, may be able to give something similar, but not always with the same levels of expertise, reputation, or history.
Consumers tend to prefer to work with corporations that have an established account and are not reliant on one individual’s talents or expertise to produce value. People want to know that a company will continue to provide support over time. That outcome is more likely going to happen with a corporation than with other business structures.
7. Corporations have a formal structure to follow.
Small businesses often operate under a single-owner structure where one person calls all of the shots. That allows the company to respond quickly to changing circumstances, but it can also become a time-consuming nightmare if the organization experiences rapid growth. Under the auspices of a corporation, there is an established hierarchy that creates a team of leaders who have specific responsibilities to fulfill in their duties.
The organization has shareholders, officers, and directors that all complete duties within the corporate framework. That structure means anyone can look at the chain-of-command to determine which person can provide the most help.
8. A corporation can protect its intellectual property and branding.
Once someone incorporates a business using the B, C, or S corporation option, it is possible to reserve the company’s name for use in that jurisdiction for a small registration charge. There is also the opportunity to file articles of incorporation on a federal level. This advantage gives the business the right to use their name throughout their country.
Other corporate structures have the option to use trademarks or intellectual property to create branding for their business. Only corporations provide the highest level of protection against name infringement from others.
9. Some corporations have more flexibility with their earnings.
If a company decides to become an S-corporation, then it will not need to pay taxes like a C-corp would under the existing codes. Individual shareholders report their earnings on their personal tax returns instead with this option, resulting in a significant amount of tax savings for some companies. It must still operate separately from the shareholders or the owner, so everyone still receives the benefit of asset separation.
If someone currently owns an LLC, it is possible to combine the benefits of the structure with that of an S-corporation. Owners would need to contact the IRS in the U.S. to make a special election using Form 2553 to achieve this outcome.
10. Ownership transfers are easy to do with corporations.
If you operate a sole proprietorship, then the business disappears the moment you decide to stop operating. Corporations act a little differently, allowing for the transfer of shares from one person to another. It can be somewhat challenging under the S-corp structure since several stock restrictions are in place to prevent people from striking it rich immediately, but these issues can often be resolved through inheritance laws or approved sales.
11. You don’t need to be a U.S. citizen to incorporate a business.
If you own an LLC, then there are no limitations on the number of investors who can own interests in the business. That includes not having limits placed on non-citizens having a role as an owner. If a corporation distributes profits to stakeholders in the form of dividends, then ownership in a C-corporation is possible for foreign nationals. The only restriction is on S-corp ownership because of the pass-through income stipulation provided for under the current tax laws.
List of the Cons of Corporations
1. There is a higher level of tax liability to manage with corporations.
When a corporation earns profits, then the money can sometimes be taxed twice in the United States. This disadvantage occurs because the business gets a tax bill for whatever it earns while individual shareholders who receive paid dividends get hit with their own bill from the government to manage. It is an outcome that happens most often with the biggest companies, so some shareholders or company owners might not see it develop.
The easiest way to avoid this problem is to receive a salary from paid work instead of dividends. That’s why you’ll see many companies deciding to go with the B or S corporation tax status instead of pursuing the idea of becoming a publicly traded company.
2. Time and cost commitments are part of the incorporation process.
It can be an expensive and time-consuming process to incorporate a business. Annual renewals are sometimes necessary to expand upon this disadvantage. Owners must prepare a series of documents, including the bylaws and the articles of incorporation, before the local government will consider the application. Whatever filing fees are necessary must be paid to the office of the Secretary of State or its equivalent in the United States to continue the process. It might take several months to complete all of this work.
A sole proprietorship in most jurisdictions requires zero paperwork to get started. You might need to apply for specific licenses or permits, but that is typically the only requirement needed to begin making some money.
3. Tax deadlines can be different for corporations than they are for private citizens.
Some corporations get taxed quarterly on their profits, which means new paperwork must be submitted for review four times per year. There can be monthly reporting duties for sales taxes and local duties. Even the annual tax deadline for C-corporations is a month earlier than it is for private citizens. It is a complex system that often requires the help of a Certified Public Accountant to navigate.
4. Some corporations have residency requirements that must be followed.
Many jurisdictions demand that the officers or board members of the corporation reside within their borders before the business registration process is considered complete. Some exceptions might apply if the company wants to register for secondary state registrations in the U.S., but an agent or contact person must be present for consumers to contact.
This disadvantage may require individual officers or board members to move to meet this requirement. If they refuse to complete the relocation process, then that person can sometimes be forced to sell their shares in the company.
5. The chain-of-command can go through frequent disruptions.
A corporation can lose its way when there isn’t consistent leadership at the top. Sometimes this issue occurs because of the presence of fractional equity shareholders, but it usually happens when there isn’t enough personal accountability built into the system. The leadership team must have some level of oversight present in the daily operations to ensure the efforts made are ethical and authentic.
When that oversight is not present, the inappropriate actions can occur. Some issues may rise to the level of criminal conduct. Several companies have received felony convictions in the United States for their behavior, and this outcome makes it possible for members of the C-Suite to serve jail time. Most convictions lead to financial penalties, but Martin Grass, the former CEO of Rite-Aid, received a plea agreement to serve eight years in prison for his conduct.
6. Corporations do not receive all of the same rights as individuals.
A corporation might receive plenty of individual rights, but it doesn’t receive the same treatment in the law as a person does in several respects. The most important difference in the United States is the lack of protection under the Fifth Amendment. A corporation must present all facts during any legal proceeding, even if the evidence implicates its own behavior. Failing to do so can lead to significant fines and penalties.
Another critical difference between corporations and individuals is the right to legal counsel. A company can provide a lawyer to manage a case, but the government will not provide one as it would to a private citizen.
7. Income losses don’t receive the same treatment under the tax law.
Sole proprietors and some general partnerships or LLCs can deduct expenses from business operations to the extent where an income loss occurs. When this outcome happens, the figures can reduce personal income levels to the point where it is no longer necessary to pay tax obligations. This process does not apply to corporations. Limits to the amount of income splitting that’s permitted exist so that there is some level of tax liability present at all times.
The owners of a corporation are not given tax credits to use when filing a return, which means they can experience the double taxation problem if they earn dividend-based income. That’s why it is essential to speak with an attorney familiar on these matters to see if it is the best business structure to pursue.
8. It takes time to dissolve a corporation.
Owners can decide to quit a corporation, but that doesn’t mean the company is going to dissolve immediately. A sole proprietor can decide instantly to stop working and that immediately closes everything. When the agency is a B, C, or S-corporation, then a resolution to dissolve must come through the leadership structure. This document must go to the jurisdiction that governs the region to indicate that no business activities will occur in the future. Tax returns must be filed for that period while regulatory compliance continues.
That’s why small businesses usually decide to become an LLC is personal asset protection is necessary.
9. Corporations go through more audits than other business structures.
A corporation might provide more credibility to investors and customers, but the IRS sees a potential place of liability. More audits occur underneath the corporate structure, especially with S-corp companies, than any other with the current tax law. If you or someone within the company were to make one simple mistake on your forms, then it could be enough for the government to drop this status. With the number of obligations required in this category, it can make management a bit tricky when compared to the B- or C-corp status.
10. Separate incorporation is required for every jurisdiction.
Businesses receive incorporation through a different process in all 50 states. If the company operates as a C-corp, then it must issue financial statements in most jurisdictions to stay in compliance. You do have the freedom to pursue the initial documentation in whatever state you prefer, there are registration processes to follow to do business in any state outside of your home one. You must follow the individual processes to ensure that you stay in compliance.
There is no national-level incorporation process to follow in the United States. Everything happens at the state level.
11. Personal asset protection is not always guaranteed by corporate law.
Just because a business incorporates itself does not mean that lenders will automatically offer loans or a line of credit. There must be enough assets within the corporation to secure debt financing. If the assets for the company are insufficient, then lenders will often insist that the owners make a personal guarantee on the debt.
If the owners agree to pursue that structure for obtaining capital, then there is still personal liability within the company. That means the debts of the business become a personal liability if a default were to occur. Individual assets can also become accessible if business and private funds intermingle as part of the corporate structure.
12. Some corporations have a restriction on the number of allowed shareholders.
Under the structure of a standard S-corporation, there is a limit of 100 shareholders in place. The company cannot have any more owners than this, or it must transition to becoming a C-corp instead. Some states classify this structure as a “close corporation,” placing additional restrictions on the number of allowable shareholders.
California limits the total number of 35, while Arizona permits only 10 or fewer original investors when creating this corporation. This structure allows for more shareholder control and a relaxed atmosphere, but it also means that individuals are left individually responsible for acts or omission that occur.
13. Some corporations may have stock concerns to manage.
If an S-corporation forms, its shares cannot be publicly traded. Organizing in this fashion if there is an idea of becoming a C-corp one day might not be the best option since there can be challenges when reselling shares. There could be a lack of interest in the market or a disagreement over its value that could lead to problems with the completion of a transaction.
Are you the owner of a business who is unsure about whether it is appropriate to incorporate your activities? Then the best outcome from this guide to the pros and cons of corporations is to speak with a legal professional familiar with this area of the law. The type of legal structure you eventually decide to use for your company can play a significant role in the success or failure of this venture.
Incorporating a business can provide you with more opportunities to secure capital, but it can also result in problems with double taxation. You and your business associates must decide together through an informed process to ensure that a positive outcome happens.
Corporations have rights just like people do, but their purpose for existence is different. Evaluate each key point in this guide to ensure your initial efforts can be as smooth as possible.
Blog Post Author Credentials
Louise Gaille is the author of this post. She received her B.A. in Economics from the University of Washington. In addition to being a seasoned writer, Louise has almost a decade of experience in Banking and Finance. If you have any suggestions on how to make this post better, then go here to contact our team.