Types of Companies > C-Corporation (Stock) > Advantages & Disadvantages

INC - Advantages & Disadvantages

C-Corp Stock Details and Steps

There are many advantages corporations have over partnerships and sole proprietorships. But there are also disadvantages. We will examine some of the most important upsides and downsides below.

Advantages:

Stockholders are not liable for corporate debts:
This is the most important aspect of a corporation. In a sole proprietorship and partnership, the owners are personally responsible for the debts of the business. If the assets of the sole proprietorship or partnership cannot satisfy the debt, creditors can go after each owner's personal bank account, house, etc. to make up the difference. On the other hand, if a corporation runs out of funds, its owners are usually off the hook.
Please note that under certain circumstances, an individual stockholder may be liable for corporate debts. This is sometimes referred to as "piercing the corporate veil." Some of these circumstances include:

If a stockholder personally guarantees a debt.
If personal funds are intermingled with corporate funds.
If a corporation fails to have director and shareholder meetings.
If the corporation has minimal capitalization or minimal insurance.
If the corporation fails to pay state taxes or otherwise violates state law.

Self-Employment Tax Savings:
Net income derived from a sole proprietorship is is treated as if it were wages and are subject to self-employment taxes, which are currently a combined 15.3%. The reason behind this is that the employer and the employee are one in the same. To illustrate this point, if we assume that sole proprietor hires a person other them him/herself, that person is treated as an employee. The employer in any type of organization will withhold payroll taxes from the employee of 7.65%. These payroll taxes are also known as FICA and medicare. The employer will also pay an equivalent amount of 7.65%. The total amount of employer and employee payroll tax collected will equal 15.3%. Because the sole proprietor is also treated as an employee, the sole proprietor shoulders both payroll tax burdens. With a corporation, only salaries are subject to such taxes; profits are not treated as wages income. This advantage is most significant for stockholder-employees who take a salary of less than $72,600.
Example: If a sole proprietorship earns $50,000, a 15.3% tax would have to be paid on the entire $50,000. If a similar organization was a corporation and also earns $50,000, but $30,000 of that amount is paid in salary, and $20,000 is classified as profits, the self-employment tax would not be paid on the $20,000 profit. This saves the stockholder-employee over $3,000 per year. Beware, it is not prudent to attempt to save money by paying yourself and unreasonably low salary to avoid payroll taxes. The IRS knows what is a reasonable range and such tactics may improve your chances of a time and money wasting tax audit.

Corporations can live forever:
Well it almost seems like it. Unlike a partnership or sole proprietorship, corporations are not forced to dissolve upon the death of its stockholders, directors or officers.

More ways to raise money:
Corporations have additional ways to raise needed capital. In addition to debt which is available to all organizational structure the corporation can sell shares of stock. It can create new types of stock, such as preferred stock, with different voting or profit characteristics.

Transferability is easier:
Ownership interests in a corporation may be sold to third parties without disturbing the continued operation of the business. The business of a sole proprietorship or partnership, on the other hand, cannot be sold whole; instead, each of its assets, licenses and permits must be individually transferred, and new bank accounts and tax identification numbers are required.
A corporation's stockholders may freely sell or transfer shares to anyone. However, with small corporations in which the stockholders act more like partners and each is integral to the success of the company, they may wish to consider placing restrictions on the transfer of shares.
Stockholders sometimes enter into a buy-sell agreement which gives the terms for when shares can be transferred or sold. A typical buy-sell agreement would state that if one stockholder seeks to sell shares to any third party, the other stockholders have a right of first refusal; that is, the other stockholders may purchase those shares at the same price. Only if the other stockholders do not purchase those shares can a stockholder sell to a third party.

Disadvantages

Higher costs:
Corporations cost more to set up and run than a sole proprietorship or partnership. A corporation is created only after legal documents have been filed with and approved by the state. Higher costs arise because there are the initial formation fees, filing fees and annual state fees.
Furthermore, a corporation must follow a variety of technical formalities. These include holding director and shareholder meetings, recording minutes, having the board of directors approve major business transactions and corporate record-keeping. If these formalities are not kept, the stockholders risk losing their personal liability protection. While keeping corporate formalities is not difficult, it can be time-consuming and may add costs to the business entity. Conversely, sole proprietors or partnerships can begin operations without any formal organizing or operating procedures.

Unemployment tax:
A stockholder-employee of a corporation is required to pay unemployment insurance taxes on his or her salary, whereas a sole proprietor or partner is not. The current federal unemployment tax is 6.2% of the first $7,000 of wages paid, with a maximum of $434 per employee.