Explain the advantages and dis-advantages of corporate investment.
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When you start a business, one of the first decisions is to decide what form is your business going to take. Will it be a corporation, an LLC, or will you operate as a sole proprietorship? The answer depends on your situation, preferences and expectations about the future growth of the business. Corporations come in two forms, and each has distinct advantages and disadvantages: C corporation and S corporation.
What is a C Corporation?
The C corporation is the most common form of incorporation. It is a separate legal entity that is owned by shareholders. Most large, publicly traded companies are C corporations.
Advantages of C Corporations
Owners have limited liability. The owners' assets are protected from the debts and liabilities of the corporation. Shareholders are not held liable for business losses.
Easier to raise capital. It is easier to attract capital with the sale of stocks and bonds. A corporation can have an unlimited number of investors.
Easy to transfer ownership. Shares of stock can be sold.
Corporations have perpetual lifetimes. The entity continues to exist beyond the deaths of the owners.
Certain expenses are tax deductible. Owners can receive tax-free benefits such as deductions for retirement plans and insurance.
Disadvantages of C Corporations
Double taxation of corporation profits. The corporation pays federal and state taxes on its profits. When dividends are paid to shareholders, they are treated as income and taxed again.
Forming a corporation costs more. Attorneys charge more to form a corporation.
States have higher fees. States charge annual franchise fees for corporations.
More state and federal regulations and oversight. Tax filings are more complicated for corporations. States require the filing of Articles of Incorporation, corporate bylaws and annual reports. Corporations must designate a board of directors and hold annual meetings.
What is an S Corporation?
S corporations combine most of the advantages of C corporations with a better tax structure for the owners.
Advantages of S Corporations
S Corporations avoid the double taxation aspect of C corporations. The income of an S corporation is not taxed at the corporate level. Instead, the reported income is passed through to the owners where it is taxed at personal tax rates.
Owners have limited liability.
Transfer of ownership of shares is easy.
S corps have perpetual lifetimes.
Owners receive tax-free benefits because the corporate can take deductions for deferred compensation plans, insurance and retirement plans.
Disadvantages of S Corporations
Only one class of stock is permitted.
S corps are limited to a maximum of 100 shareholders.
Stockholders types are limited. Stockholders can only include individuals, estates and trusts. Other corporations, partnerships and non-resident aliens cannot own shares of an S corporation.
Starting a new business as a sole proprietorship is the easiest business form at the beginning. However, as the business grows, converting to a corporation gives the company options to raise capital, attract new shareholders, and provide personal asset protection for the owners. Even though the initial cost to form a corporation is substantial and there is a lot of paperwork, the corporate form is beneficial to the shareholders in the long term.
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