Question

Corporations

This week, we learned about the different types of corporations. Write an essay discussing the disadvantages and advantages of the various types of corporations. This essay should include information on corporations, S corporations and limited liability corporations.   

Answer 1

Types of Corporations

Corporations

S corporations

Limited Liability Company

Anyone who operates a business, alone or with others, may incorporate. This is also true for anyone or any group engaged in religious, civil, non-profit or charitable endeavours. You do not have to be a business giant to be able to have the financial and other benefits of operating a corporation. Given the right circumstances, the owner(s) of a business of any size can benefit from incorporating.

If you choose to run your business as a corporation, whether as a LLC, a C Corp or a S Corp, you will have chosen a organizational business structure that relieves you and other owners of much of the personal financial liability.

Keep in mind, however, that officers can still be held liable for their actions as they relate to the business.

When a business is set up as a corporation, the law views it as a separate entity from its owners. While you and your business are one and the same under a sole proprietorship, you are distinct under a corporation.

It is more expensive and time consuming to set up a corporation and, depending on the type of corporation and other factors, your business taxes may actually go up.
Still, there are advantages.

The business can sell stock to raise additional capital and there are some tax benefits as well.

Which business structure type is right for your business depends on many factors. If you’re not sure which is right for you, seek help from a financial professional or tax attorney

General Corporation

This is the most common corporate structure. The corporation is a separate legal entity that is owned by stockholders. A general corporation may have an unlimited number of stockholders that, due to the separate legal nature of the corporation, are protected from the creditors of the business. A stockholder’s personal liability is usually limited to the amount of investment in the corporation and no more.

Corporation Advantages

• Owners’ personal assets are protected from business debt and liability
• Corporations have unlimited life extending beyond the illness or death of the owners
• Tax free benefits such as insurance, travel, and retirement plan deductions
• Transfer of ownership facilitated by sale of stock
• Change of ownership need not affect management
• Easier to raise capital through sale of stocks and bonds

Corporation Disadvantages

• More expensive to form than proprietorship or partnerships
• More legal formality
• More state and federal rules and regulations

Close Corporation

There are a few minor, but significant, differences between general corporations and close corporations. In most states where they are recognized, close corporations are limited to 30 to 50 stockholders. In addition, many close corporation statutes require that the directors of a close corporation must first offer the shares to existing stockholders before selling to new shareholders.

This type of corporation is particularly well suited for a group of individuals who will own the corporation with some members actively involved in the management and other members only involved on a limited or indirect level.

S Corporation

With the Tax Reform Act of 1986, the S Corporation became a highly desirable entity for corporate tax purposes. An S Corporation is not really a different type of corporation. It is a special tax designation applied for and granted by the IRS to corporations that have already been formed. Many entrepreneurs and small business owners are partial to the S Corporation because it combines many of the advantages of a sole proprietorship, partnership and the corporate forms of business structure.

S Corporations have the same basic advantages and disadvantages of general or close corporation with the added benefit of the S Corporation special tax provisions. When a standard corporation (general, close or professional) makes a profit, it pays a federal corporate income tax on the profit. If the company declares a dividend, the shareholders must report the dividend as personal income and pay more taxes.

S Corporations avoid this “double taxation” (once at the corporate level and again at the personal level) because all income or loss is reported only once on the personal tax returns of the shareholders. However, like standard corporations (and unlike some partnerships), the S Corporation shareholders are exempt from personal liability for business debt.

S Corporation Restrictions

To elect S Corporation status, your corporation must meet specific guidelines. As a result of the 1996 Tax Law, which became effective January 1, 1997, many of these qualifying guidelines have been changed. A few of these changes are noted below:

• Prior to the 1996 Tax Law, the maximum number of shareholders was 35. The maximum number of shareholders for an S Corporation has been increased to 75.
• Previously, S Corporation ownership was limited to individuals, estates, and certain trusts. Under the new law, stock of an S Corporation may be held by a new “electing small business trust.” All beneficiaries of the trust must be individuals or estates, except that charitable organizations may hold limited interests. Interests in the trust must be acquired by gift or bequest — not by purchase. Each potential current beneficiary of the trust is counted towards the 75 shareholder limit on S Corporation shareholders.
• S Corporations are now allowed to own 80 percent or more of the stock of a regular C corporation, which may elect to file a consolidated return with other affiliated regular C corporations. The S Corporation itself may not join in that election. In addition, an S Corporation is now allowed to own a “qualified subchapter S subsidiary.” The parent S Corporation must own 100 percent of the stock of the subsidiary.
• Qualified retirement plans or Section 501(c)(3) charitable organizations may now be shareholders in S Corporations.
• All S Corporations must have shareholders who are citizens or residents of the United States. Nonresident aliens cannot be shareholders.
• S Corporations may only issue one class of stock.
• No more than 25 percent of the gross corporate income may be derived from passive income.
• An S Corporation can generally provide employee benefits and deferred compensation plans.
• S Corporations eliminate the problems faced by standard corporations whose shareholder-employees might be subject to IRS claims of excessive compensation.
• Not all domestic general business corporations are eligible for S Corporation status. These exclusions include:
  • A financial institution that is a bank;
  • An insurance company taxed under Subchapter L;
  • A Domestic International Sales Corporation (DISC); or
  • Certain affiliated groups of corporations..

Limited Liability Company (LLC)

LLCs have long been a traditional form of business structure in Europe and Latin America. LLCs were first introduced in the United States by the state of Wyoming in 1977 and authorized for pass- through taxation (similar to partnerships and S Corporations) by the IRS in 1988. With the recent inclusion of Hawaii, all 50 states and Washington, D.C. have now adopted some form of LLC legislation for both domestic and foreign (out of state) limited liability companies.

Many business professionals believe LLCs present a superior alternative to corporations and partnerships because LLCs combine many of the advantages of both. With an LLC, the owners can have the corporate liability protection for their personal assets from business debt as well as the tax advantages of partnerships or S Corporations. It is similar to an S Corporation without the IRS’ restrictions.

LLC Advantages

• Protection of personal assets from business debt
• Profits/losses pass through to personal income tax returns of the owners
• Great flexibility in management and organization of the business
• LLCs do not have the ownership restrictions of S Corporations making them ideal business structures for foreign investors

LLC Disadvantages

LLCs often have a limited life (not to exceed 30 years in many states) Some states require at least 2 members to form an LLC, and LLCs are not corporations and therefore do not have stock — and the benefits of stock ownership and sales.