Which of the following is a disadvantage of corporations

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 nonresident 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.

Organizing your business as a corporation offers many advantages, but there are also disadvantages that must be considered.

Sometimes, it is a double-edged sword. The attractive things about a corporation may also present a downside, depending on what your business is or how you would like to run it.

Key Takeaways

• The disadvantages of forming a corporation may depend on you and your goals for your company.
• Corporations have a board of directors, which can complicate decision making and can even result in you losing control of the company.
• Corporations can be expensive and complicated to form depending on the state you're organizing in.
• Forming a corporation could result in double taxation.

See the reasons in this article to determine if the downsides are worth the rewards of forming a corporation.

Distinct Legal Entity

If your business is your idea and passion in life, it is important to understand that you will not be the personal owner. A corporation is a distinct legal entity that is governed by a board of directors.

It is possible that even if you started the corporation, a board could take control of the business, leaving you without a say. A board often has the ability to fire the founder and vote other board members out.

Note

There are federal and state rules and regulations that dictate who can serve on a board of directors. In most cases, family members and spouses cannot serve on a small corporation’s board simultaneously.

If you need to maintain total control of your business, you should consider another form of business structure.

Double Taxation

Another disadvantage of forming a corporation is the double taxation requirement. C corporations pay taxes on profits when corporate income is distributed to owners (shareholders) in the form of dividends. This is the first taxation.

The shareholders who receive dividends must also pay taxes for this distribution on their personal returns. This is the second taxation of the same money.

Note

There is another option within incorporation. You can form an S Corporation tax status to avoid double taxation.

The corporation itself does not pay taxes twice, but just the sound of “double taxation” can make potential business owners cringe. However, there is another option. Choose the Internal Revenue Service (IRS) S Corporation tax status to avoid double taxation.

Expensive to Form

There are many filing fees associated with forming a corporation. Formation fees can vary state-to-state, ranging from as little as $45 to as high as $315.

Note

Most states also require corporations to file annual documents and/or franchise tax fees. Nonprofits typically also have to pay fees for registering their charity each year.

Nonprofits must file even more paperwork because they must apply to the IRS for tax exemption status (minimum $750 to apply). In a few states, nonprofits may also have to file separately for state tax exemption status. Even small fees can add up if you are cash-strapped already.

Complicated to Form

Corporations must file Articles of Incorporation with the state they are incorporating in, for which states charge different filing fees. They may also need to file ​bylaws, which may require the help of an attorney to write.

Note

Many entrepreneurs file all their own paperwork. However, if you are new to business, you should at least consult with a business attorney before attempting to form a corporation on your own.

Extensive Rules to Follow

There are many standards required by law on how a corporation governs itself. Corporations must have a board of directors, hold meetings at determined intervals, and keep certain records. If a corporation sells stock or has a membership, there are many other rules that apply.

Starting a business is a big commitment of time, resources, and money. Before deciding on the type of business to form, it is important to weigh all of the pros and cons of each business structure.

Frequently Asked Questions (FAQs)

What are the advantages of forming a corporation?

Some of the advantages of forming a corporation are limited liability, ease of raising money and business name protection.

Which of the following is a disadvantage of corporations quizlet?

What are 5 disadvantages of corporation?

Which of the following is a disadvantage of the corporate form?