New Venture Lab: Equipping Christian Entrepreneurs

Question

Can you please tell me more about Corporations?

Answer

A corporation is a state-chartered entity -- by the state in which it is headquartered -- and is considered by law to be a unique entity, separate and apart from its shareholders. The shareholder owners elect a board or directors (or board of governors) as a governance structure to oversee the management team, policies, strategy, financial reporting and executive compensation.  As a separate entity, a corporation can be taxed, it can be sued, it can enter into contractual agreements, and it lives on in perpetuity since it does not dissolve when the shareholders depart, sell their shares or die.

Advantages of a Corporation:

• Shareholders have limited liability for the corporation's debts or legal judgments, but the liability varies based upon the role:
  • Regular shareholders have no liability beyond the risk of their investment in the shares
  • Directors and Officers can be held personally liable for their decisions and actions (think Enron), but typically carry Directors and Officer's (D&O) insurance to further protect themselves
• Corporations can raise capital through a stock offering, either private or public
• Corporations have greater flexibility on deducting benefits costs
• May have a hybrid structure such as an S corporation or Limited Liability Corporation that has a pass-through tax status similar to partnership

Disadvantages of a Corporation:

• The process of incorporation is complex and takes more time and money than do sole proprietorships or partnerships
• Corporations are subject to additional regulation and scrutiny by governmental regulators and agencies at the local, state and federal levels to insure shareholder protection and director and officer integrity
• C corporations have a double tax (at the corporate level and at the shareholder level, which can, but not always, result in higher overall taxes, since shareholder dividends are not deductible from business income, but are taxed as income for the shareholders

Federal Tax Forms for Regular or "C" Corporations  (others may apply)

• Form 1120 or 1120-A: Corporation Income Tax Return
• Form 1120-W Estimated Tax for Corporation
• Form 8109-B Deposit Coupon
• Form 4625 Depreciation
• Employment Tax Forms
• Other forms as needed for capital gains, sale of assets, alternative minimum tax, etc.

Subchapter S Corporations

Also known as S corps, this is actually a tax election that allows the corporation to pass through the earnings directly to the shareholder, who is taxed on his personal tax return and thereby avoiding the double tax that is typical of C corporations.  Shareholders that do take the S corp election must take a "reasonable compensation" or paid at "market" rates for the role you are filling, all taxed as regular compensation.  Switching back from an S corp to a C corp may make you liable for catch-up on taxes and you should consult with your tax advisor prior to changing from one type of corporation into another.

Federal Tax Forms for Subchapter S Corporations  (others may apply):

• Form 1120S: Income Tax Return for S Corporation
• 1120S K-1: Shareholder's Share of Income, Credit, Deductions
• Form 4625 Depreciation
• Employment Tax Forms
• Form 1040: Individual Income Tax Return
• Schedule E: Supplemental Income and Loss
• Schedule SE: Self-Employment Tax
• Form 1040-ES: Estimated Tax for Individuals
• Other forms as needed for capital gains, sale of assets, alternative minimum tax, etc.

Limited Liability Company or Limited Liability Corporation (LLC)

This structure -- not available in all states -- is designed to provide the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership, a hybrid if you will that tries to bring the benefits of both structures into one type of entity.

The shareholders of an LLC are typically called members and the nature of the entity is somewhat limited compared to a C corp in that an LLC cannot have more than two of the four characteristics that define corporations: continuity of life, limited liability, centralization of management and transferability of ownership interests.  However, consult with your attorney, as most limitations with this structure, such as a limited life, can be extended or otherwise mitigated.

Federal Tax Forms for LLC (others may apply):

• Form 1065: Partnership Return of Income
• Form 1065 K-1: Partner's Share of Income, Credit, Deductions
• Form 4562: Depreciation
• Form 1040: Individual Income Tax Return
• Schedule E: Supplemental Income and Loss
• Schedule SE: Self-Employment Tax
• Form 1040-ES: Estimated Tax for Individuals
• Employment Tax Forms