A traditional Corporation (or a “C” Corporation) is a business structure that is created as a separate, distinct legal entity from its owners (or “shareholders”). Once a corporation is formed, the corporation can have it’s own bank accounts, own property, conduct business, and even establish a line of credit, irrespective of the individual accounts or credit of the shareholders. The primary advantage to having a business formed as a corporation is the fact that the shareholders are not personally liable for the debts and legal liabilities incurred by the corporation. For example, if a corporation is sued for business reasons and loses, the shareholders will not be required to satisfy the debts of the corporation from their own personal assets. This safeguards assets and properties of the individual shareholders, and as such, is more attractive to potential investors.
Once a corporation is established, the shareholders must name (via election) a board of directors that is responsible for the operation of the business, making business decisions, and managing all business-related affairs. This board is elected by the shareholders of the corporation, and once named, the board appoints “officers” of the corporation to specific duties. This usually includes a secretary, a treasurer, etc.
Another important thing to know about the formation and maintenance of a corporation is that certain corporate formalities must be observed. These are things like a required annual meeting of the board of directors, the necessity to maintain the corporate “minutes,” the separation of corporate and personal funds (no “co-mingling” of funds), and a necessity to maintain written agreements for all corporate transactions (including internal transactions such as internal loans, executive compensation agreements, etc.).
Advantages of a Corporation
- Limited Liability for Shareholders
- Certain Tax Benefits
- Prestige for the Business and Corporate Officers
- Ability to raise capital and attract investors
A major disadvantage of the traditional corporation is the dreaded “double taxation” dilemma. A traditional C Corporation pays tax on all corporate (business) income, then once a distribution is made to the shareholders, the individual shareholders pay income tax again on these distributions (or dividends). One way to avoid the double taxation dilemma is to establish the corporation as a “pass through” entity like a partnership wherein all corporate profits pass through to the individual shareholders and they are then responsible for the tax burden. A corporation that has made the election to be treated in this manner (by making the appropriate filings and meeting the requirements) is known as an “S Corporation.”
Disadvantages of a C Corporation
- Double Taxation pitfall
- Increased paperwork
- Necessity of exercising the corporate formalities
Incorporating is one of the first legal steps towards taking your business venture to the next level and important if raising capital is necessity. A Savvy investor would review business model and position, and see the “inc.” after your business as a sign that the business is a serious venture and worthy of his investment. This is a critical step towards making investors feel comfortable and give serious consideration towards investing capital in your enterprise!
An S Corporation (named in such a manner because of it’s organization meeting the IRS requirements to be taxed under Subchapter S of the Internal Revenue Code) is a corporation that is structured in such a manner as to provide a pass-through entity for tax purposes, much like a partnership whose income or losses “pass through” to the individual shareholders’ personal tax returns (in direct proportion to their investment or ownership in the company), while still providing the same protections for assets and from liabilities as a traditional corporation. The shareholders will pay personal income taxes based on the S corporation’s income, regardless of whether or not the income is actually distributed, but they will avoid the “double taxation” that is inherent to the traditional corporation (or “C” corporation).
The Major Difference between a traditional Corporation and an S Corporation
Because of its “pass through” taxation structure, the S corporation is not subject to taxes at the corporate level, and hence avoids the pitfalls of “double taxation” (in a standard or traditional corporation, business income is first taxed at the corporate level, then the distribution of the residual income to the individual shareholders is taxed again as personal “income”) that befalls C corporations.
Unlike C corporation dividends which are taxed at the federal rate of 15.00%, S corporation dividends (or more properly titled “Distributions”) are taxed at the shareholder's marginal tax rate. However, the c corporation dividend is subject to the double-taxation mentioned above. The income is first taxed at the corporate level before it is distributed as a dividend and then taxed as income when issued to the individual shareholders.
For example, Cogs Inc, is formed as an S corporation, makes $20 million in net income and is owned 51% by Jack and 49% by Tom. On Jack's personal tax return, he will report $10.2 million in income and Tom will report $9.8 million. If Jack (as the majority owner) decides not to distribute the net income profit, both Jack and Tom will still be liable for taxes on the earnings as if a distribution was made in that manner, even though neither received any cash distribution. This is an example of a corporate “squeeze-play” that can be used in an attempt to force out a minority partner.
Groups of certain professionals can form corporations known as professional corporations or professional service corporations (“PC”). The list of professionals covered by professional corporation status differs from state to state; though it typically covers accountants, engineers, physicians and other health care professionals, lawyers, psychologists, social workers, and veterinarians. Typically, these professionals must be organized for the sole purpose of providing a professional service (for example, a law corporation must be made up of licensed attorneys). A professional corporation offers many of the limited liability and taxation benefits offered by a traditional corporation.
In certain states, this is the only incorporation option available for certain professionals, whereas in others, they are given the choice of being either a professional corporation or S or C corporation.
Professional corporations can shield owners from liability. While it can't protect a professional from his/her own malpractice liability, it can protect against liability from negligence of an associate and this is the primary reason professionals form these type of corporations.
Nonprofit Corporations are formed in order to conduct activities and transactions for purposes other than shareholder financial gain, while at the same time providing the same asset protections and limited liabilities of a standard corporation. A nonprofit corporation can make a profit, but this profit must be used strictly to forward the goals rather than to provide earned income (in the form of dividends) to its shareholders. It is understood that most of the transactions and activities of a Nonprofit Corporation will not be commercial in nature.
The Major Difference between Nonprofit and For-Profit Organizations
Most experts consider that it is the legal and ethical restrictions on the distribution of profits to owners or shareholders which fundamentally distinguishes nonprofits from “for-profit", or commercial enterprises. A more precise term to describe most nonprofit organizations is 'not-for-profit', rather than 'nonprofit', and this is often used in legislation and texts.
Nonprofit corporations generally do not operate to generate profit, a defining characteristic of such organizations. However, a nonprofit organization may accept, hold and disburse money and other things of value, and it may also legally and ethically trade at a profit, provided that the proviso that any profit generated will be used to further its cause, goal or mission is adhered to. The extent to which it can generate income may be constrained, or the use of those profits may be restricted. Nonprofits therefore are typically funded by donations from the private or public sector, and often have tax exempt status. Private donations may sometimes be tax deductible.
Additionally, a nonprofit organization may have members as opposed to shareholders.