This is the last article in our series on choosing an organizational entity for your business in Ohio. In our previous articles, we looked at sole proprietorships and partnerships, along with things to consider when choosing an entity, and then we looked at limited liabilities companies. Below we’ll compare the advantages and disadvantages of corporations as business entities. Depending on the size of a business, its capitalization and taxation needs, and the founders’ tolerance for regulatory compliance and government reporting, corporations can be an ideal because of the options uniquely available to these entities.
Corporations are the most widely recognized corporate structure, with stockholders, directors and officers that are so familiar to everyone. Corporations require more formalities for organization, more regulatory compliance, and more reporting requirements than any of the other business entity options available in Ohio. They also offer significant protection from liability, similar to limited partnerships or LLC’s, granting stockholders near immunity from business liabilities. For businesses with a need for outside capital from numerous investors or family-owned businesses desiring to share business interests with non-participating family members, corporations present some ideal solutions.
Corporations are also inherently perpetual, meaning that the life of the company is not tied to the stockholders and can continue operating beyond the life or loss of any particular stockholder. While a similar objective can be achieved with limited partnerships and LLC’s, the term of an LP or LLC must be defined in the company’s operating agreement and is not inherent.
The primary downside to owning a corporation is that, unlike limited liability companies, shares of stock are subject to the claims of creditors of the individual owners. Creditors with a judgment against a debtor can lay claim to that debtor’s shares in a corporation but not to their shares in a limited liability company. Oftentimes, for this reason alone, many clients are converting their closely held corporations to limited liability companies.
Corporations have the choice of two taxation plans. They can choose to be taxed under Subchapter C of the U.S. Internal Revenue Code, or they can choose to be taxed under Subchapter S. Corporation structures are commonly referred to as C Corporations or S Corporations, depending on which Subchapter they are taxed under. Let’s take a look at what the differences mean.
For raising capital and ease of transferring ownership interest of a company, a C corporation can’t be beat. There’s no limit to the number of shareholders a C corporation can have and, for the most part, no restrictions on who can own stock or transfer it. Preferences can be given to various classes of stock for purposes of distributions, which means some stockholders can receive larger distributions than other stockholders.
Many venture capitalists and banks favor the familiarity of C corporations, and if a business is planning to go public, there really isn’t any other option. C corporations also offer the unique advantage of being able to treat stockholders as employees, which means they can take advantage of health plans and retirement plans, which are tax deductible to the company, without including the cash value of such benefits as income.
As noted previously, the downside of C Corporations is the high level of complexity and regulatory compliance required. Corporate stocks are considered securities and all distributions and transfers must comply with federal securities regulations. Additionally, the company must file minutes of stockholders and directors meetings annually and all organizational documents are public record. Other record keeping requirements may also apply.
A downside that is unique to C corporations is the “double-taxation” phenomenon. Earnings are taxable at the corporate level and distributions to stockholders are taxed at the personal level. For all other corporate entities (except LLC’s opting to be taxed as corporations), this phenomenon is avoided as they function as pass-through entities and income is only taxed at the personal level. Another tax-related disadvantage is that corporate losses cannot be deducted from stockholders’ income. Corporate losses can be deducted from the income of general partners of limited partnerships, LLC members and S corporation stockholders.
In respect to organization, filing requirements, and securities compliance, S corporations are almost identical to C corporations. Where they differ is in the limitations on creation of stock and taxation. S corporations are limited to a maximum of 75 shares and only one class of stock may be created, meaning distribution preference can’t be given to certain stockholders over others. Additionally, only U.S. citizens are allowed to own stock in an S corporation.
As already mentioned, S corporations are a pass-through entity and are taxed like partnerships. Income is only taxed at the personal level, avoiding the double-taxation of C corporations, and corporate losses can be deducted from stockholders’ income on their tax returns. Because of the pass-through effect, S corporation stockholders are treated more like self-employed business owners than corporate stockholders for taxation purposes. Any benefits for stockholders paid for by the company are taxed as income for the stockholders and are not tax deductible for the company.
S corporations are often advantageous as an organizational entity for family businesses because of the flexibility to distribute business interests among family members who are not actively involved in business operations. Shares can be distributed without the federal double-taxation and many other complications associated with C corporations. However, S corporations do not offer the flexibility of C corporations and LLC’s for giving distribution and allocation preferences to classes of stockholders or members.
There’s a lot of information to consider when selecting the entity for a business. Largely it boils down to whether your priorities are about simplicity, control, flexibility, liability or capitalization. As a business owner, do you prefer to keep it simple and keep all the funding responsibilities, liability risks and profits for yourself? Or are you willing to jump through some hoops to minimize your risk and create more options for funding and profit sharing? Our first article in this series included more specific questions to consider when selecting a business entity: Identifying the Ideal Organizational Entity for Your Business, Part 1: Sole Proprietorships and General Partnerships.
As we noted in our second article, at Gudorf Law Group, LLC we most often recommend limited liability companies as the best entity form for small businesses and professional practices in Ohio. LLC’s offer the greatest flexibility for ownership distribution, management control, and income distribution with minimal regulation or vulnerability to liability risks and unnecessary taxation.
Get help structuring your business to fit your goals and needs
In Ohio, the business planning attorney’s office of Gudorf Law Group, LLC, can assist in identifying and setting up the ideal business entity for your company, reduce your exposure to liability, and create opportunities to share business profits with family members or take advantage of outside investors without surrendering control of your business. Call our office at 1-877-483-6730 to schedule a free consultation.