The ABCs of Incorporation
One question that a business should revisit from time to time is whether its current organizational structure is meeting its needs. Sole proprietorships, partnerships, and limited liability companies (LLCs) are fairly basic forms of ownership, whereas corporations are significantly more complex.
A corporation is a separate legal entity from its owners, which means shareholders generally cannot be held liable for a corporation’s debts. S and C corporations may provide broader legal protections, but usually must meet more demanding regulatory requirements.
In addition, many states now recognize the legal status of benefit corporations, which may appeal to for-profit businesses with a stated “social mission.”1
Both S and C corporations must file annual tax returns, but they are taxed very differently. S corp profits and losses are “passed through” to the owners, who are taxed at personal income tax rates, even if profits are later reinvested in the business to pay for new employees or equipment. C corporations could be subject to the corporate income tax at both federal and state levels, but they may be able to deduct the salaries and bonuses of owners and employees as business expenses. Any dividends distributed to C corp shareholders are paid from the corporation’s after-tax profits and are taxable to the recipients, creating the potential for double taxation.
An S corp shares many of the formal corporate requirements as a C corp, including articles of incorporation (and other document filings), a board of directors, an annual meeting, corporate minutes, and shareholder votes on major decisions. Larger and fast-growing companies are commonly organized as C corps because multiple classes of stock and an unrestricted number of shareholders are allowed. S corps are limited to one class of stock and a total of 100 shareholders.
Accounting for the Greater Good
Normally, corporations might be compelled to make economic decisions that maximize profitability for shareholders, which can result in legal or ethical challenges for some firms. Benefit corporation status may provide legal protection by mandating other considerations, including the potential impact on employees, the environment, or the community.
Becoming a benefit corporation only affects requirements of corporate purpose, accountability, and transparency. It does not affect a company’s tax status, which means it can still elect to be taxed as a C corp or an S corp.
When choosing an organizational structure for your business, it’s important to weigh the potential costs and benefits of the various options and consult with your tax and legal professionals.