If you are starting your own business, you may be weighing the type of entity you should choose. One of those options is the corporation, but what type is best for you?
Choosing the right type of business entity is a personal choice. It depends in part on how you want to run your business, in part on your tolerance for risk, and in part on how you would be taxed. There are pros and cons to consider with each type.
Advantages and disadvantages of incorporation
One of the main advantages of forming a corporation is that it shields you from personal liability for business debts and losses. A corporation is a separate legal entity from its owners, so it is fully liable for debts and losses on its own. If you were to act as a sole proprietorship or set up as a partnership, this would not be true.
Another significant advantage of incorporation is that you can sell stock, meaning that you can borrow from investors to run your business venture. It also allows you to offer stock and stock options to employees and officers of the corporation.
Finally, there is a predictable and durable power structure with a corporation. It is run by a board of directors and officers who report to shareholders. Each group has clearly defined responsibilities.
On the downside, incorporation requires a bit more time and effort to set up than some other business entities. You will need to create formal articles of incorporation, bylaws and a shareholder agreement, for example.
Once you have set up as a corporation, you will need to follow the formalities of running a corporation or you will lose its advantages. This includes holding regular board meetings, keeping legally competent records and issuing an annual report.
Types of corporations
The two most popular types of corporations are the “S” and “C.” These are designations based on a tax election. An S corporation is one where the corporate income, losses, credits and deductions will pass through to the shareholders, requiring them to report income and losses on their personal income tax returns.
In order to qualify for an S designation, your corporation must be domestic, have no more than 100 shareholders who are individuals, trusts and estates, have only one class of stock and be otherwise eligible under the IRS’s rules. A C corporation is one that does not meet the requirements for an S corporation.
There are several additional types of corporations, as well, including close corporations, professional corporations and non-profit corporations.
Creating a corporation takes a certain degree of knowledge and expertise, and it is not recommended that you attempt it without an experienced business attorney.