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to operate all kinds of businesses. While their exact legal status varies somewhat from jurisdiction to jurisdiction, the most important aspect of a corporation is the limited liability protection. This means that shareholders have the right to participate in profits but are not held personally liable for the company's debts.
There are several different types of corporations, including “C” Corporations, “S” Corporations, Close Corporations, Benefit Corporations, Professional Corporations, and Nonprofit Corporations. There are many differences between them and an understanding of each is required to decide which one is right for you.
C Corporation
A C Corporation is a business term that is used to distinguish this type of entity from others, as its profits are taxed separately from its owners under subchapter C of the Internal Revenue Code. This is known as “double taxation,” whereby the C Corporation is taxed on its earnings or profits and the shareholders are taxed again on the dividends they receive from those earnings. A C Corporation is owned by shareholders, who must elect a board of directors who make business decisions and oversee policies. Because a corporation is treated as an independent entity, a C Corporation does not cease to exist when its owners or shareholders change or die. Some of the major benefits of a C Corporation include:
Its owners (known as shareholders or stockholders) enjoy limited liability and they are generally not personally liable for the debts incurred by the corporation. They cannot be sued individually for corporate wrongdoings.
It can deduct the cost of benefits as a business expense; for example, it can write off the entire costs of health plans established for employees.
The corporate profits can be split among the shareholders and the corporation. This can result in overall tax savings, as the tax rate for a corporation is usually less than that for an individual.
It can have an unlimited number of shareholders, as this allows the corporation to sell shares to a large number of investors, and allows for more funds to be raised.
It allows for foreign nationals to have a right to own or invest in a C Corporation, which allows for diverse investors to participate in the business.
It can offer different “classes” of stock, such as common or preferred, to different shareholders, which can help attract different groups of investors.
S Corporation
An S Corporation stands for “subchapter S corporation,” a special tax status granted by the Internal Revenue Code that allows corporations to pass their corporate income, credits, and deductions through to their shareholders. Generally speaking, S Corporations do not pay income taxes as the company's individual shareholders divide the income among each other and report it on their own personal income tax returns. An S Corporation status lets businesses avoid double taxation, which is what happens when a business is taxed at both the corporation level and business owner level, such as with a C Corporation. An S Corporation must adhere to the following limitations:
It must be a domestic corporation, which is based and operated in the United States of America.
It can only have “allowable” shareholders, meaning that none of the shareholders can be partnerships, other corporations, or non-U.S. citizens.
It cannot have more than 100 shareholders in total.
It can only have one class of stock: common.
All of the company's shareholders must unanimously consent to an S Corporation status.
An S Corporation offers several advantages, such as:
It is exempt from federal income tax except for certain capital gains and passive income. It allows profits to pass through to its shareholders and the income is then taxed on the shareholder's personal tax returns at each shareholder's individual tax rates.
It allows for limited liability protection for personal assets that are separate from the assets of the business. Shareholders are not personally liable for the company's debts or liabilities, and for the most part, creditors are not able to go after the shareholders personally to recover business debts.
It allows for flexibility in how to characterize the income for tax purposes. As a shareholder of a corporation, you can also be an employee of the business and pay yourself a salary, which is taxed at your tax rate. In addition to your salary, you can pay yourself dividends from the corporation that are generally taxed at a lower rate than the employee salary. This helps reduce self-employment tax liability, as long as you are characterizing your salary and dividend in a reasonable way.
It allows for easy transfer of ownership without causing significant tax consequences or terminating the corporate entity.
Close Corporation
A Close Corporation, also known as a family corporation, is generally a smaller corporation that elects close corporation status and is therefore entitled to operate without the strict formalities normally required in the operation of standard corporations. Many small business owners find this benefit invaluable. In essence, a Close Corporation is a corporation whose shareholders and directors are entitled to operate much like a partnership. The Close Corporation election is made at the state level and the state laws vary with respect to the eligibility of close corporation status and with respect to the rules governing them. Some states do not authorize them. The requirements to be eligible for a Close Corporation status include: no more than 30 to 35 shareholders, it cannot make a public offering of its stock, and shareholders must agree unanimously to a close corporation status. Close Corporations enjoy relaxed rules with respect to the formalities of governance, such as shareholders typically need not hold formal annual meetings and the shareholders may override the directors and act on their own.
Benefit Corporation
A Benefit Corporation is a relatively new type of business entity. Originally implemented by legislation in Maryland in 2010, this new entity is now recognized in half the states, while legislation is pending in many others. A Benefit Corporation is a for-profit corporation entity that in addition to profit also takes society and the environment into consideration when making decisions. The goal of this corporate structure is to encourage for-profit companies to identify social missions and demonstrate corporate sustainability efforts. To be recognized as a Benefit Corporation the company must include:
Purpose: Benefit Corporations commit to creating public benefit and sustainable value in addition to generating profit. This sustainability is an integral part of their value proposition.
Accountability: Benefit Corporations are committed to considering the company's impact on society and the environment in order to create long term sustainable value for all shareholders.
Transparency: Benefit Corporations are required to report to their shareholders, and in most cases the wider public, in most states annually and using a third-party standard, showing their progress toward achieving social and environmental impact.
Becoming a Benefit Corporation has advantages for everyone in and related to your business, from shareholders and directors to your customers. These benefits include:
Expanded Shareholder Rights: Investing in a Benefit Corporation gives impact investors the assurance they need that they will be able to hold a company accountable to its mission in the future. This could aid companies in attracting impact investment capital.
Reputation for Leadership: Your business will join other high profile, highly respected companies as Benefit Corporations and be at the forefront of a growing movement.
Attracting Talent: According to Inc. Magazine writer Peter Economy, by 2020, Millennials