In previous posts (Choice of Entity: A Primer for the New Business Owner Part 1 and Part 2) we discussed starting a business as proprietorship (single owner, with no entity) and as a limited liability company. In the third installment of this series we will discuss the pros and cons of operating your business as a C corporation.
Similar to a limited liability company, a C corporation is formed by filing organization documents with the state in which the business will have its primary headquarters. In Maryland and the District of Columbia, a C corporation is formed by filing Articles of Incorporation with the State Department of Assessments and Taxation.
The primary benefits of operating as a C corporation:
- Limited liability. Just like limited liability companies, the stockholders of a C corporation are not personally liable for the debts or obligations of the business unless they have expressly assumed those liabilities (for example by signing a personal guarantee). Note that a there are circumstances under which courts will allow a creditor to “pierce the corporate veil” and collect a company obligation directly from a stockholder. The circumstances under which this can happen are extremely limited however.
- Multiple classes of stock. C corporations can issue different classes of stock. The differences can be operational (voting vs non-voting shares) or economic (shares with a priority as to dividends) or both. Note that there is another kind of corporation, known as an S corporation in which the ability to differentiate among classes of stockholders is extremely limited. S Corporations will be discussed in more detail in the next installment.
- Historical precedent. Business owners have been operating as corporations in the United States for almost as long as there has been a United States. Stockholders of corporations can take comfort in the relative stability and certainty that over 200 years of case law and historical precedent provides.
- Crowdfunding under the Jumpstart Our Business Startups Act of 2012. Crowdfunding (such as Kickstarter®) has greatly expanded over the last several years and has become a go-to place for entrepreneurs and start-ups. If and when the Securities and Exchange Commission gets around to issuing regulations governing the crowdfunding provisions of this Act, C corporation status may prove beneficial to entrepreneurs seeking to raise capital.
The disadvantages of operating as a C corporation:
- Potential for double tax. C corporations must pay tax on the profits they generate. If those profits are then paid to stockholders in the form of dividends, the stockholders will be taxed on those dividends as well. Note that with proper tax planning, the amount of tax paid by a C corporation on its profits can be minimized and in many cases eliminated entirely.
- Formality and recordkeeping. There are many formal requirements that C corporations must comply with under state law in order to maintain their corporate status. For example, a C corporation must (i) issue stock (or, if, permitted under applicable law, authorize uncertificated shares); (ii) adopt bylaws; (iii) elect a board of directors (some exceptions) and a slate of corporate officers; (iv) hold and document annual meetings of its stockholders; and (v) provide certain information to its stockholders (even minority stockholders) annual and on request. Compare this with a limited liability company that has almost no formal requirements other than filing of its organization document with the state.
- Cost. Generally speaking, because of the additional formalities discussed above, forming and maintaining a C corporation will be more expensive than a proprietorship, limited liability company or partnership.
Generally speaking, there not many situations where operating as a C corporation will be advantageous for a small business startup. As noted in previous posts however, every new business is unique and the prudent entrepreneur will carefully consider all of the available options with her or his accounting advisor and business attorney before deciding on a structure for the new business.
For more information on starting a new business, contact JGL’s business lawyer, Jerry Miller.