Corporations play an indelible role in the everyday lives of the American public, perhaps now more than any other time in history. Corporations fund student loans, create and supply the cell phones we carry with us at all times, and manufacture the cars we drive.
While the term corporation is used generically to describe a company, there are many different types of corporations. Each type of corporation has advantages and disadvantages regarding taxation, raising capital, and management of the company. This article discusses the types of corporations available to business owners and explores their pros and cons.
A corporation is a legal entity organized under the laws of a certain state, that once approved by the state, is regarded as a separate legal entity that is apart from its owners. A corporation is formed by filing Articles of Incorporation with the Secretary of State of whatever state the company wants to operate in. In the Articles, the corporation states its purpose and the number of shares and type of shares it will issue. After filing the articles, the company issues stock to shareholders in exchange for money or assets. Selling stock allows corporations to raise capital for the business.
The feature that distinguishes corporations from other business forms, like Limited Liability Companies or Partnerships, is that corporations must follow certain corporate formalities. These formalities including electing a board of directors once a year. The board includes a president, secretary, treasurer, and other officers.
The board is important because it makes decisions on behalf of the company and owes fiduciary duties to its shareholders. These duties include the duty to be loyal to the corporation and its shareholders, as well as the duty to act in good faith and fairness. The board counsels the company on important decisions and provides crisis management during times of turmoil. This is why the board of directors of large corporations often include prominent, experienced people. For example, Apple, Inc.’s Board of Directors includes Apple’s CEO, Tim Cook, and former Vice President of the United States, Albert Gore, Jr.
The board votes on and adopts bylaws that determine the role and authority of the board and shareholders. The board must meet monthly to discuss corporate management and must keep minutes from each meeting. Stockholders’ meetings must be held annually after all stockholders are given notice of the meeting. Corporations must also keep a variety of records, including every time stock is sold or transferred.
Generally speaking, all corporations have limited liability so long as the corporate formalities are observed. Limited liability means the personal assets of the individual board members, managers, and shareholders, cannot be reached to satisfy the debts and obligations of the business. A shareholder is never personally liable for the debts of the business, and at most risks their investment in stock.
A corporation is legally treated as a person and has many of the same legal rights. For example, in Citizens United v. Federal Election Committee, The Supreme Court found that corporations had the same First Amendment rights as individuals to contribute to political campaigns.
A C Corporation (C-Corp) is the most common type of corporation. C-Corps and S Corporations get their names from the Internal Revenue Service Code and the tax election chapters associated with each corporation. A defining feature of the C-Corp is double taxation. C-Corps are taxed first when the company profits, and second when the company pays dividends to shareholders. Shareholders then pay taxes for profits through their personal tax returns.
C-Corps have limited liability for debts and liabilities. Limited liability means that the managers and shareholders of the corporation cannot be held personally liable for the corporation’s debts or liabilities. This is advantageous for businesses that are medium or high-risk because the owners do not have to risk their personal assets if the business faces financial or legal issues.
An S Corporation (S-Corp) is a type of corporation that avoids the double taxation faced by regular corporations, so named because it is formed under Subchapter S of the IRS Code. S-Corp’s enjoy pass-through taxation, meaning corporate income and losses pass through to the shareholders for tax purposes. The shareholders pay personal taxes at individual tax rates.
S-Corps enjoy the same limited liability as LLCs and Corporations. The owners of S-Corps generally pay themselves a salary, unlike LLCs which pass all profits through to the individual members.
Creating an S-Corp requires filing Form 2253 with the IRS rather than the state and making a formal election to operate as an S-Corp. Only certain corporations can qualify as an S-Corp. For example, only corporations with one class of stock and 100 shareholders or less can register as an S-Corp. S-Corps also require the same burdensome corporate formalities as other types of corporations, which must be followed at all times. Overall, an S-Corp may be a good alternative to a traditional C Corp for those businesses that can quality to a traditional corporation in order to avoid double-taxation.
Close or Closely Held Corporation
A closely held corporation, often called a close or private corporation, is a corporation owned by a small group of people who do not sell their stock for ownership. Close corporations are often owned by the company’s founders or a group of investors.
Closely held corporations do not sell stocks on the public market, and thus cannot raise capital by selling shares. One advantage to that is that closely held corporations do not have to file disclosure statements with the Securities and Exchange Commission or public disclose their financial documents. This allows closely held corporations to operate with more anonymity than public corporations.
Closely held corporations are not necessarily small in size simply because they are privately owned. Examples of large closely held corporations include Chik-Fil-A and State Farm. Closely held corporations can often make decisions more quickly than public corporations given that many, or all, of the shareholders are on the board of directors. A closely held corporation can become a public company by going through the process of offering stock for sale to the public through an initial public offering.
A public corporation, as contrasted with a close corporation, is a corporation owned by public stockholders. A public corporation has sold most or all its stocks at an initial public offering to the public and is thus subject to public reporting requirements. The shareholders who buy stocks are part owners of the company. The company’s stocks are traded on the international stock market where anyone can buy them. Examples include Apple, Inc., Alphabet, Inc. (Google’s parent company), and Microsoft Corporation.
Public companies are required to file quarterly earnings reports with the Securities and Exchange Commission, which are available to the public. The biggest advantage of a public corporation is selling stock on the international market, which allows public companies to raise huge sums of money.
Non-Profit and Not-for-Profit Corporation
A non-profit corporation is a separate legal entity organized for a charitable purpose, which is allowed to accept charitable donations. Many non-profits are organized under Section 501(c)(3) of the Internal Revenue Code, which means they are organized for a purpose such as religion, charity, education, or science.
Non-profits are exempted from paying income tax on donations due to the fact that their purpose is to serve a charitable goal, such as mentoring youth like Big Brothers Big Sisters of America. Public universities may also qualify as non-profits. For example, the University of California school system, which has ten campuses and five medical centers across the state, qualifies for 501(c)(3) tax exempt status.
Non-profits cannot operate to make a profit and cannot pass dividends onto the board of directors or leadership. All income must be reinvested into the organization.
Similarly, a not-for-profit corporation can operate as a non-profit organization or a charitable organization. It cannot operate in order to make a profit, and all dividends or earnings are put back into the organization to achieve its objectives. Generally, not-for-profits do not enjoy the same tax-exempt status as non-profits but can apply for tax-exempt status. Not-for-profit corporations do not pay sales or property tax but do pay taxes on payroll to their employees.
A professional corporation (PC) is a corporation owned and operated by licensed professionals engaged in the same business want to incorporate. The shareholders, board of directors, and officers must belong to the same profession. Attorneys, engineers, and accountants traditionally organized as professional corporations.
PC’s are desirable because it is easy to transfer shares to other people when one person leaves the business or retires. PC’s have limited liability, which is desirable for professional businesses that require licenses because it means that one partner will not be liable for another partner’s malpractice. Each state has different rules as to what types of professions can form PC’s, so they may not be available in every state or to every profession that requires a license.
Which Corporation Type is Best?
Each corporation type has advantages and disadvantages. Every corporation must adhere to corporate formalities, including electing a board of directors that meets regularly, providing notice to shareholders of annual meetings, and complex filings related to state and federal tax obligations. Corporations are generally advantageous because of limited liability for owners, board members, and shareholders.
C-Corp and S-Corp refer to tax elections made by a corporation. An S-Corp has an advantage over a C-Corp for companies that can qualify because it avoids double taxation. Those companies that do not qualify have to operate as C-Corps or another type of corporation.
A public corporation can be either a C-Corp or S-Corp. A public corporation is defined as a corporation that has public disclosure obligations due to offering shares of the company on the stock market. A public corporation is desirable for a company that needs to raise capital to fund its business. Offering stock to the public can raise large amounts of money quickly.
However, public corporations must comply with additional filing and disclosure requirements to the Internal Revenue Service and Securities and Exchange Commission. Public corporations must also disclose their earnings publicly, which allows them to be open to scrutiny by potential investors and the shareholders.
Closely held corporations (private corporations) do not have the same public disclosure requirements as public corporations. This is because they do not offer stock to the public on the stock market. Closely held corporations are advantageous because they are owned by a small group of people, who often sit on the board of directors. The owners can make decisions fairly quickly and keep tighter control over the business operations than public companies, which are owned by many shareholders.
Non-profit corporations are highly desirable in that they can accept donations, and at the same time pay no income, sales, or property taxes. Not-for-profits are similar in that they can accept donations and do not pay sales or property tax. This allows them to make large amounts of money from charitable donations. Not all corporations will qualify as a non-profit or not-for-profit because the goal of the corporation must be one that qualifies for tax exemption, such as a religious, social, or educational purpose.
However, unlike other corporate types, they cannot pay dividends to their owners or leadership. All profits must be put back into the company. Conversely, for the other types of corporations, there is no limit on the dividends and bonuses they can pay their shareholders or leadership.
The best type of corporation for any business depends largely on the purpose of the business, how much capital the business needs, and which way the business desires to be taxed.