Choosing the Right Legal Entity for Your Startup - Exploring Corporations
- Choosing the Right Legal Entity for Your Startup - Exploring Corporations
- What Are the Best Types of Businesses to Operate as Corporations?
- Who Is Eligible to Operate as a Corporation in the US?
- How to Register a Corporation?
- What Are the Key Advantages of Corporation?
- What Are the Key Disadvantages of Corporation?
- Partnership vs. Sole Proprietorship vs. LLC vs. Corporation
- How is a Corporation Taxed?
- Pros and Cons of Corporation Taxation
- How to Convert a Corporation?
Starting a new business is exciting, but it also comes with some critical decisions you must make. One of the most important things you must decide is the type of business structure you want for your business. You can choose sole proprietorship, partnership, LLC, or corporation. If you choose a corporation, you have options within that designation that may or may not fit your needs.
According to U.S. Census Bureau data, only around 5.6% of companies in the U.S. are designated as corporations. Although this percentage is much lower than that of other forms of business, the revenue generated by these companies is significantly higher. Most corporations fall under the category of S-Corp., or C-Corp., but other types are also available.
Corporations are much more complex than other entity structures but offer options unavailable with other types. When forming your company, you must take the time necessary to learn as much as possible about the pros and cons of each type and which best suits your needs now and in the future. Explore the information below to learn what a corporation is, the different types, how they work, how they are taxed, and the unique features and benefits that corporations offer.
What is a Corporation?
A corporation is a legal entity formed by one or more individuals, a group, or a company. State law grants a corporation the right to act as its own entity. Once formed, the corporation has legal rights and responsibilities that mimic an individual's. The corporation can sign contracts, sue others and be sued, borrow or loan money, and own its own assets, and it must pay taxes at tax time. One of the key points about a corporation is its limited liability. Shareholders receive profits through dividends and stock options but are not personally liable for anything the corporation does or the company’s debts or obligations. Most large companies are corporations. A company that is structured as a corporation is referred to as “incorporated.”
There are a few varieties of corporations; they are as follows:
- C-Corporation (C-Corp):
A C-corporation is a for-profit legal entity separate from its owners that can raise capital through stock sales. Shareholders own stock and have limited liability. A C-corporation is taxed as a corporation.
- S-Corporation (S-Corp):
An S-corporation is similar to a C-Corp but allows for pass-through taxation, meaning shareholders are taxed on profits, and the corporate entity is not taxed, avoiding double taxation.
- Limited Liability Company (LLC):
A unique entity combining limited liability with pass-through taxation like a partnership or sole proprietorship. LLCs are not true corporations but offer similar protections and tax structure.
- Benefit Corporation (B-Corp):
A for-profit entity taxed like a C-Corp or S-Corp, certified by B Lab Global, and held to high social, environmental, accountability, and transparency standards to create positive impact.
- Nonprofit Corporation:
Operates for charitable, educational, religious, scientific, or public benefit purposes, typically tax-exempt and operating without profit.
- Cooperative Corporation (Co-op):
Owned and operated by its members, who share profits and losses. Members are employees or patrons, and decision-making is democratic.
- Professional Corporation (PC):
An entity formed by licensed professionals (like doctors, lawyers, accountants) that offers limited liability and tax benefits, with all owners licensed in the same profession.
Key Features of Corporation
Understanding what a corporation is and how it works are the building blocks to making a decision about the type of structure you want for your company. Corporations, like other business entities, have unique features. The key features of a corporation are:
What Are the Best Types of Businesses to Operate as Corporations?
Choosing to operate as a corporation is a big decision and depends on your goals for the company, your size, your financial situation, and your industry. Typically, corporations work best for businesses that need limited liability, want to raise capital easily by selling stock, and are looking toward long-term growth. Very large companies are usually structured as corporations. Some examples of the best types of businesses to operate as corporations include:
Big Tech Companies:Examples include Windows, Apple, Dell, Meta, and Sony. They need liability protection and raise capital by selling millions of shares of stock.
Banks and Finance:Banks, brokerage firms, and financial companies benefit from corporate status to raise capital through stock sales and handle complex financial transactions.
Insurance Companies:Large insurance firms use the corporate structure for limited liability protection and to raise funds by selling stock.
Healthcare:Healthcare organizations, pharmaceutical companies, and hospitals operate as corporations to manage large operations and mitigate risks.
Manufacturing:Automotive and consumer goods manufacturers use corporations to handle complex supply chains and production systems.
Retail:Large retail chains and ecommerce companies operate as corporations to manage inventory, distribution, and diverse customer bases.
Energy and Utility Companies:Oil, gas, and electricity companies use corporate structures to manage infrastructure projects and comply with federal regulations.
Transportation:Airlines, railroads, and trucking companies form corporations to handle large fleets, routes, and logistical operations.
Food and Agriculture:Food production and processing companies use corporate structures to manage global supply chains and meet strict regulations.
Aerospace:Airplane and defense manufacturers operate as corporations to secure government contracts and manage large-scale projects.
Legal Companies:Some large law firms or specialized legal service providers incorporate to manage multiple locations and services.
Who Is Eligible to Operate as a Corporation in the US?
If you have decided you would like to operate as a corporation, you must first ensure that you qualify. The items that the U.S. government requires before you can establish a corporation are as follows:
- Domestic Corporation:
To operate as a corporation, you must be a domestic company residing inside the United States or an individual or group of individuals who are U.S. residents.
- Only Allowable Shareholders:
You must also have only allowable shareholders who are not partnerships, other corporations, or non-resident alien shareholders.
- Single ClassName of Stock:
You must also have only one className of stock.
How to Register a Corporation?
The steps to forming a corporation are more complex than other types of company structures. However, with good, solid legal help, you can do so in a fair amount of time and be up and running. Use the list of steps below to get started forming your own corporation.
The first step is to choose your corporation’s name. At the end of it, you will add “Inc.” You may choose to add “Corporation” to your name instead. Keep the name simple, impactful, and related to your business activity. Don’t choose too long a name that is hard to remember or spell. The goal is to make it easy for your customers to find you and remember your name.
Check with your Secretary of State to ensure the name is available. You cannot use an existing name or one close to your chosen business name. Also, check the U.S. trademarks database to see if your proposed company name is already in there. You do not want to infringe on anyone’s trademark.
You can incorporate your company in any state within the U.S. Take some time to learn about the corporate laws, taxes, and fees to find a state that works best for you. Consider how easy or hard it is to incorporate in that state and how much it will cost you. Some states offer a more business-friendly environment.
Appoint a company or person to be your registered agent. This entity will receive legal and other official notifications on the company’s behalf. The person or business you choose must have a legal address in the state of incorporation. Some corporations use their lawyer to be their registered agent.
Have an attorney draft your Articles of Incorporation, including the company name, purpose, and structure. File the completed and signed Articles of Incorporation with your state agency, which is most often the Secretary of State.
Along with your Articles of Incorporation, have your lawyer draft your corporate bylaws detailing the internal operations and procedures you intend to base the company upon. Some things to include are shareholder meetings and when they occur, board of directors elections and how they work, and officers of the corporations and their duties, responsibilities, and roles.
The IRS requires corporations to register for an EIN (employer identification number) regardless of whether or not they hire employees. This crucial step is easy to accomplish. Log onto the IRS.gov website, and you can register your corporation and get an EIN within a few days. You will need this EIN when you apply to open a business bank account.
Once your corporation is fully formed, you can hold your first board meeting. During the meeting, you can elect your officers, issue stock certificates, and address any initial organizational matters that arise.
When issuing stock, you must determine the number of shares to issue, the type, and their par value. Prepare stock certificates to issue, which represent ownership in the corporation. The more stock someone owns, the more their share.
If your business sells goods, you must also register with your state’s tax agency so you can pay sales tax on every product you sell. The local tax authority differs from state to state, and some sales do not have a sales tax. If you plan on operating in multiple states, you must do this in every state where you do business. Check with your state tax office to learn more about this step.
Find a corporate business insurance agent and purchase policies that protect you against catastrophic financial loss in case of legal issues or other problems. You will also need commercial auto insurance if you use vehicles in your business.
Apply for as many business bank accounts as you need to keep all business activities in one place. According to corporate laws, you must keep the corporation’s money separate and apart from any board members or shareholders.
What Are the Key Advantages of Corporation?
The various types of entity structures come with pros and cons. Best practices dictate you investigate them to get the whole picture. A corporation has some built-in features that benefit its owners. The key advantages of a corporation are as follows:
What Are the Key Disadvantages of Corporation?
Along with the many advantages of a corporation, there are a few disadvantages you need to familiarize yourself with before going in that direction. The key disadvantages of a corporation include:
Partnership vs. Sole Proprietorship vs. LLC vs. Corporation
Corporations offer the maximum amount of protection through limited liability. Shareholders are not held accountable for the corporation’s debts, obligations, or wrongdoing. They are shielded against any personal loss. However, that protection does not come without a price. Corporations are more expensive and complex to establish. Other types of entities, like sole proprietorships and partnerships, are fully exposed personally. Corporations also sell stock and can raise capital quickly. Plus, they are seen as the most professional, stable, and legitimate type of business entity. That cannot be said of the other types. Other business entity types offer pass-through taxation, but with a corporation, the profits are taxed twice (typically at lower rates).
Review the chart below to learn about the different types of entities and how they compare. If your goals align with the facets of the information below, a corporation might be the best fit for you.
| Characteristic | Sole Proprietorship | Partnership | LLC | S-Corp | Corporation (C-Corp) |
|---|---|---|---|---|---|
| Formation | Quick and simple with no filing requirements with any government agency. | Simple to create with no legal filing requirements. | More expensive to create and requires filing with the state. | An S-Corp is more costly to establish, and it requires state filing. | It is more expensive to establish and requires filing with the state. |
| Cost of Formation | None | None | The cost of the state filing fee is usually between $100-$150. | The cost of registering an S-Corp with the state can be anywhere between $20 and $800. | The average cost to register a C-Corp in the United States is $633. |
| Business Name | Can operate under the owner’s name, or a fictitious name using a DBA. | Can operate under the owner’s name, or a fictitious name using a DBA. | Must register an official company name with the state that is established and secured. | Must register an official company name with the state that is established and secured. | Must register an official company name with the state that is established and secured. |
| Taxation | Pass-through taxation, where all everything is filed under the owner’s personal taxes. | Filed under the partners. Each partner claims their income and losses on their personal returns based on their percentage of the business. | Pass-through taxation, where everything is filed under the owner’s personal taxes. If there are multiple owners, taxation is treated like a Corporation. | Each owner declares their share of profits/losses on their personal returns. Income is allocated based on owner percentage. Owners can use corporate losses to offset other types of income. Fringe benefits are limited to owners who own more than 2% of the shares. | The C-Corp is a separate taxable entity that must file returns. Owners split profits and only declare their portion on personal income tax returns. Owners can deduct fringe benefits as business expenses. |
| Liability | The owner is personally liable for all business actions, liabilities, debts, and damages. | Owners are personally liable for all business debts. | Business is its own entity; therefore, the owner(s) are protected against personal liability. | Owners have limited liability for personal debts, and business legal issues. | Owners have limited liability for personal debts and business legal issues. |
| Operational Requirements | No operational requirements are necessary. | No operational requirements are necessary. | More formal requirements than an LLC but not as strict as a C-Corp. | Much easier to maintain than a corporation. Annual member meetings and a report are required. | Annual meetings are required, and members must vote on changes. Shares of stock must be sold to raise capital. |
| Management | Full control of all decisions, management, and operations. | Each partner has equal control and decision-making ability unless it’s a limited partnership. | An operating agreement outlines how each member can manage the company. | Managed by a group of directors that shareholders vote in. | Managed by a group of directors that shareholders vote in. |
| Raising Capital | Can be challenging and the owner often has to invest his/her own money. | Each partner can invest, and more partners can be added to raise additional capital. | Managers can sell interest in the business to raise capital based on operating agreement restrictions. | Can sell shares of stock to raise capital. | Can sell shares of stock to raise capital. |
| Transferability of Interest | No | No | Possible based on the operating agreement restrictions. | Yes, as long as IRS regulations about who can own stock are honored. | Shares of stock can be easily transferred. |
How is a Corporation Taxed?
Corporate profits are taxed according to the 21% federal corporate tax rate. Profits are the corporation’s income minus expenses. Corporations may deduct expenses such as cost of goods sold (COGS), operating expenses, general and administrative items, sales and marketing, research and development, and depreciation, among other things. Once all the expenses have been deducted, this leaves the corporation’s taxable income, which is then multiplied by 21%, which is the tax due. Tax experts can lower the taxable income even further with government subsidies and tax loopholes.
In addition to the corporate tax, shareholders are taxed on the corporation's dividends. Their tax rates will vary based on their tax bracket and individual deductions. This is the second part of the double taxation. Shareholders will use Form 1099-DIV to claim this income.
Those who wish to avoid double taxation can file to be taxed as an S-Corporation, which means it would use pass-through taxation, and only the business owners will be taxed on profits through their own returns.
Corporate tax returns are due April 15th of every year using Form 1120. Corporations can request a six-month extension if they need more time to prepare. Corporate tax payments are due in April, June, September, and December.
Some states, like North Carolina and New Jersey, also impose a corporate income tax, which can be very low but also a substantial expense.
Corporations allow some special deductions that may not apply to other business entities. These are as follows:
- Employee Salaries:
Payroll is considered a necessary expense and, therefore, deductible on corporate taxes.
- Employee Benefits:
Employee benefits like health plan coverage, paid time off, tuition, and bonuses are also tax deductible for corporations.
- Insurance Premiums:
Insurance premiums can be a significant corporate expense. Fortunately, they are also deductible.
- Travel Expenses:
Business travel expenses like hotels, flights, taxis, and gas/mileage are also tax deductible.
- Bad Debts:
When customers fail to pay, you may write the amounts off as bad debt, but did you know you can also use them as tax deductions?
- Taxes (Sales, Fuel, Excise):
In the course of doing business, you may have to pay sales tax, fuel taxes, and excise taxes. You can deduct these expenses from your corporate tax return.
- Tax Preparation Fees:
You can also deduct the cost of preparing your taxes.
- Legal Fees:
Corporate legal fees are tax deductible.
- Bookkeeping:
Bookkeeping charges are also considered necessary expenses and tax deductible.
- Advertising:
Advertising and marketing fees are tax deductible on your corporate return.
- Investments/Real Estate:
If the company makes investments or buys real estate, you can also deduct those on your return.
Pros and Cons of Corporation Taxation
It may be easier for a corporation to pay income tax than for individual owners or shareholders. Plus, the company can deduct expenses for medical insurance, retirement plans, and tax-deferred trusts, lowering its tax burden, whereas an individual cannot. Additionally, corporations can also deduct losses. The downside of corporate taxation is that income is taxed twice.
Use this table below from the IRS to be sure you are filing the correct forms:
How to Convert a Corporation?
In the corporate world, things can change quickly or over time. There may come a day when you decide to convert your corporation to another type of business entity. Doing so may be easy or hard, depending on your conversion. The complexity depends on what kind of entity you want to be and state laws regarding conversion. Some of the reasons you may want to convert include:
- Easier Management:
Sole proprietorships, partnerships, and even LLCs are easier to manage than corporations.
- Fewer Corporate Requirements:
Corporations are required by law to hold meetings and file reports regularly and are subject to strict compliance regulations. Formation is more complex and costly. Another business entity could simplify things.
- Flexible Operations:
Corporations have a very rigid management structure. If you want more flexibility about running your business, another entity like an LLC could offer you more options.
- Pass-Through Taxation:
Take advantage of pass-through taxation if you switch from a corporation and avoid double taxation.
- Change in Liability:
If the business operations change to the point that there is very little risk, you may not require limited liability, and switching to a simpler structure makes sense.
Corporation to Sole Proprietorship
Switching from a corporation to a sole proprietorship requires you to completely dissolve the corporation first and establish a new sole proprietorship. The steps to accomplish this are as follows:
- Review the corporate bylaws about dissolution and comply with them.
- Hold a vote and have shareholders pass a resolution to dissolve the corporation.
- Notify all creditors of the dissolution.
- Pay any outstanding taxes.
- File a final tax return.
- File Articles of Dissolution with the Secretary of State or other applicable state agency.
- Transfer the remaining assets to the sole proprietorship or to you personally.
- Register the new business name.
- Apply for a new EIN under the sole proprietorship’s name.
- Apply for any licenses and permits required by your industry.
- Open new bank accounts or update existing ones.
- Inform vendors and suppliers of the change.
- Update your insurance records and coverage.
- File a DBA (doing business as) form if required.
Corporation to Partnership
When converting from a corporation to a partnership, you must completely dissolve the corporation, liquidate the assets, and distribute them to shareholders before forming your new entity. The steps to do this include:
- Review the corporate bylaws about dissolution and comply with them.
- Hold a vote and have shareholders pass a resolution to dissolve the corporation.
- Liquidate the corporate assets (property, equipment, etc.) and convert them into cash.
- Pay off any remaining debts.
- Distribute the remaining assets to shareholders.
- Consult a tax professional to deal with any remaining tax issues.
- Choose a partnership name and register it with the Secretary of State.
- Draft a partnership agreement.
- Apply for a new EIN under the partnership name.
- Apply for any licenses and permits required by your industry.
- Open new bank accounts or update existing ones.
- Inform vendors and suppliers of the change.
- Update your insurance records and coverage.
- File a DBA (doing business as) form if required.
Corporation to an LLC
If you choose to convert your corporation to an LLC, the process is that you will create a new LLC, transfer the assets from the corporation to the new LLC, and then dissolve the corporation. The steps are as follows:
- Choose a new name for your LLC and file it with the Secretary of State.
- Designate a registered agent.
- File your Articles of Incorporation with the Secretary of State.
- According to the corporation’s bylaws, formulate a plan to transfer the assets.
- Transfer all assets and liabilities from the corporation to the LLC. Consider a merger; it can be simpler.
- Hold a shareholder meeting to get approval to dissolve the corporation.
- File a Certificate of Merger or dissolve the corporation.
- Apply for a new EIN under the partnership name.
- Apply for any licenses and permits required by your industry.
- Open new bank accounts or update existing ones.
- Inform vendors and suppliers of the change.
- Update your insurance records and coverage.
- File a DBA (doing business as) form if required.
Converting from a corporation to a lower-tiered business entity is complex and risky. Hire an attorney to help you ensure you take all the necessary steps to avoid any penalties or legal issues.
Check with your state office to review the specifics of corporate law and how to change your corporation into a new business entity.
- Choosing the Right Legal Entity for Your Startup - Exploring Corporations
- What Are the Best Types of Businesses to Operate as Corporations?
- Who Is Eligible to Operate as a Corporation in the US?
- How to Register a Corporation?
- What Are the Key Advantages of Corporation?
- What Are the Key Disadvantages of Corporation?
- Partnership vs. Sole Proprietorship vs. LLC vs. Corporation
- How is a Corporation Taxed?
- Pros and Cons of Corporation Taxation
- How to Convert a Corporation?