C corporations are one of the oldest forms of business entity in the country and one of the most common. As a result, some businesses may instinctively form as C corporations without really considering the pros and cons as applied to their business model. It is important to note that C corporations operate under state law. As a result, some issues regarding regulation will vary.
Benefit – Limited Liability
A corporation is an independent entity from its shareholders. As a result, arguably the chief benefit of a C corporation is that its owners are generally protected from being personally liable for the business’s liabilities and obligations. The shareholders are not protected from the corporation’s liabilities if they misuse corporate funds, the shareholders intentionally ensure that the business lacks the assets to pay off its liabilities, corporate formalities are not observed, or if the shareholders use the corporation to defraud others.
Benefit – Shareholders Can Sue
Another benefit of corporate entity independence is that shareholders can sue on the corporation’s behalf. A derivative suit is brought when a corporation’s directors and management have failed to use their authority in the corporation’s best interest. An example of an appropriate basis for a derivative suit is if an officer misappropriated a corporate opportunity. A shareholder may also file direct lawsuits. While the grounds for a derivative lawsuit are based on duties owed to the corporation, direct lawsuits are based on duties owed to the individual shareholder. A common direct suit is trying to compel dividend payment.
Benefit – Perpetual Existence
Other business entities, such as partnerships and sole proprietorships, are tied to the owners. However, since the corporation is its own legal entity independent of any owners, it can “live” indefinitely. As a result, the other owners of the business do not have to worry about the business dissolving if one owner dies or decides to leave.
Benefit – Ease of Transferability
Because the corporation has an indefinite life, it is easier for corporate owners to transfer their shares to other individuals. Since the business will not cease if one owner leaves, there are often fewer restrictions on transfers. Also, most publicly traded businesses are C corporations. A public forum to trade shares with a large number of possible customers increases transferability.
Disadvantage – Double Tax
Arguably the biggest negative is that C corporations are “double taxed.” When a C corporation earns income, the C corporation is taxed. Then anytime the corporation issues a dividend, the shareholders are taxed on the amount they receive. As a result the income is “taxed twice.”
Disadvantage – Complicated Formalities
To form, a corporation must draft articles of incorporation and bylaws. The articles detail the corporation’s name, address, business purpose, the name of its registered agent and how many shares of stock it will issue. A new corporation must also draft bylaws that establish formalized meetings for shareholders and appoint a board of directors to establish general corporate strategy. The bylaws must consider every major business decision, from obtaining financing to amending the bylaws, and come up with an approach for it. The sheer amount of required proceedings can be overwhelming.
Disadvantage – Expensive to Maintain
To form, a business must pay $100 to $1,000 in fees to incorporate, depending on the state. When other costs associated with preparation of the corporate tax return, compliance with corporate formalities, and the double taxation of corporate profits are considered, a C Corporation can be quite expensive to its shareholders.
Disadvantage – Many Legal Requirements
C corporations often face significant legal hurdles. In addition to filing articles of incorporation and their own tax returns, many states require that corporations spell out specific provisions regarding how the corporation’s management will handle internal affairs. Also, if a corporation is established in one state and wishes to do business in another, it must receive permission from the second state to operate there. If the C corporation wishes to go public, it faces another set of federal laws regarding how it may issue and sell its stock.