The Corporation as a Legal Entity for your Small Business

A C Corporation is the most expensive of your choices for legal entities for your small business to operate under.  It is also the most complex.  It is independent and separate from its owners.  As such there are more regulations and tax requirements for which your  small business must comply.

Of course, the biggest benefit for the small business owner who decides to incorporate  is the liability protection it receives.  If you organize your small business as a corporation you are not putting your personal assets at risk because in a corporate structure debt is not considered to be that of the owners.

It is easier to raise money in a corporate structured environment. Small business owners are able to sell both preferred and common stock to raise money for their company.

Corporations continue indefinitely, even in the event of a shareholders death or disability.  Of course all shareholders are entitled to sell their stock whenever they please.

Corporations come with a number of downsides.  Here are a few.

1.  We have already the higher costs to get up and running and to continue to operate.

     Corporations are formed under the laws of each state, and of course each state has its

     own set of rules and regulations.  As most of you know, government bureaucracy

     is alive and well in federal, state, and city levels.  It is extremely hard to navigate

     through them all.  Small business people find them just as frustrating as everyone else.

     Almost all small businesses need the help of an attorney to guide them through the

     maze of paper required to be set up legally

2.  And as we’ve already discusses, corporations require more accounting and tax

     preparation services.  Those tax laws keep changing them each year.  Looks like the

     government entities involved with making the tax laws should have it down pat by

     now, considering how long they’ve had to practice!

3.  Double taxation is a definite downside. Owners of the corporation pay a double tax on

     the earnings of the business.  Dividends are taxed as well as the taxes a corporation

     has to pay on income to both the state and federal taxing authorities.  Any dividends

    distributed to shareholders are taxed at the individual shareholder’s tax rates on their

    personal income tax returns.

   One very good strategy that many small businesses use to help ease the blow of double

   taxation is to pay out hefty salaries to the major shareholders and any other

   shareholders who work for the company. 

   A corporation is not required to pay tax on earnings paid as reasonable compensation,

   and it can deduct the payments as a business expense. 

   The caveat here is what is “reasonable” compensation.  Big Brother IRS has

   limits of course, so be careful how hefty your weekly paychecks are. 

   Check with the IRS regulations to be sure you stay within the guidelines for what is fair

   and reasonable.

Bottom line is that any money you’ve invested in a corporation is at risk.  Despite the liability protection of a corporation as a viable legal entity for a small business, you will find that most banks and “traditional” lenders along with many small business suppliers will require owners to sign personal guarantees so they know the corporate owners will make good if any debt of the small business if the corporation can’t.

I would suggest starting out with just about any other legal entity in the start-up phase of your small business before jumping into a C Corporation.  But be sure to consult a trusted CPA and/or an Attorney first.