What Is a Disadvantage of the Corporate Form of Business Entity?

By River Braun, J.D.

What Is a Disadvantage of the Corporate Form of Business Entity?

By River Braun, J.D.

Corporations are separate legal entities that enable you to run a business with minimal liability. Compared to other entities, corporations offer greater flexibility when it comes to raising money and transferring ownership. Before deciding to form a corporation, however, consider the following disadvantages that might overshadow any benefits.

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Complex Paperwork Requirements

Out of all business forms, corporations are the most complex to form and operate. Additionally, establishing a corporation can be time consuming and more expensive than other business structures. Formation documents include the Articles of Incorporation and corporate bylaws. If you are new to the corporate world, it may be helpful to engage the services of a corporate attorney to assist with the initial filing documents and ensure that the corporation is formed correctly.

Once formed, the corporation is subject to more government oversight than other business forms. Because of this increased oversight, corporations must keep careful record of all business activities, including financial reports and meeting minutes. In contrast, a limited liability company (LLC) has less formal requirements, while still offering asset protections.

Subject to Double Taxation

Double taxation means that the corporation is required to pay taxes and the shareholders must also pay taxes on dividends they receive. Furthermore, the dividends are not deductible from taxable income, and if you are an employee of the company, you must also pay self-employment taxes.

LLCs and S corporations are not subject to double taxation. Dividends are taxed only on the personal level — not the business level. For smaller companies, structuring your business as an LLC or an S corporation may make better financial sense. Companies that are structured as S corporations have profits that flow directly to shareholders instead of being taxed at the corporate level. S corporations are smaller companies with less than 100 shareholders and restrictions on stock types. Some states, like Texas, Tennessee, District of Columbia, and New Hampshire, still tax S corporations as C corporations, so be sure to check with your state laws when deciding whether or not to incorporate.

Less Autonomy in Decision Making

Corporations are not owned by a single person — they are owned by the board of directors and shareholders. While you may have been the brains behind the product, it is possible for the board of directors to remove you from the company that you helped establish.

Making the decision to start a business is not to be taken lightly. The best way to avoid the more common pitfalls faced by companies is to do your homework before taking steps to incorporate. For some, forming an LLC or S corporation is a better option that will provide more security for founders, reduce tax liability, and result in less government oversight than the traditional C corporation structure. During the first few years of business activity, tax losses are common due to initial start-up costs, which makes starting out as an S corporation even more attractive. An S corporation can always transition to a C corporation in later years.

Before you form your corporation, consider speaking with business attorneys and tax professionals about the pros and cons of each business structure.

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