Corporation

A corporation is a legal entity that is distinct from its owners.

How it’s Formed: The business owners form the corporation by filing a certificate of incorporation (also called a “charter”) with the state’s corporate filing office, usually the Secretary of State. 

How it’s Taxed: C-corporations are taxed at the entity level when income is earned and at the stockholder level when income is distributed. 

Key Benefits:

  • Can protect the members and employees and their assets against certain types of personal liability (though, members and employees may still be personally liable for certain claims, like those related to negligent acts and debts that they personally guarantee).
  • Can issue equity in the corporation, which makes it easier to raise third-party capital by selling equity to investors. 

Key Downsides:

  • In the case of a C-corporation, profits are taxed to the corporation when earned and also to the shareholders when distributed as dividends. There is no tax deduction when the corporation distributes dividends to shareholders and shareholders can’t deduct losses of the corporations on their personal returns.

Other Considerations:

  • S-Corporations
    • S-corporations are sometimes recommended when the business grows to a certain size or revenue level. An S-corporation is not a separate business entity. S-corporations are corporations or LLCs that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. It is a tax treatment applied to an existing business entity. The business owners would first form the entity and then elect to be taxed by the IRS as an S-corporation by filing Form 2553 Election by a Small Business Corporation with the IRS.
    • In the case of an S-corporation, the company is not subject to corporate income tax. It is treated as a partnership for tax purposes (meaning that the business income passes through to the owner’s personal tax return).
    • S-corporations can be beneficial for business owners because the owner becomes an employee of the business and can split the business income into a portion that is paid to the business owner as employee wages and taxed as income, and a portion that is paid to the business owner as a shareholder distribution and is taxed as capital gains. 
    • To qualify for S-corporation status, the corporation must:
      • Be a domestic corporation
      • Have only allowable shareholders (i.e., may be individuals, certain trusts, and estates, and may not be partnerships, corporations, or non-resident alien shareholders)
      • Have no more than 100 shareholders
      • Have only one class of stock
      • Not be an ineligible corporation (i.e., certain financial institutions, insurance companies, and domestic international sales corporations)
  • Benefit Corporations
    • Some U.S. states have passed legislation that allows business owners to incorporate as benefit corporations. A benefit corporation (sometimes called a “public benefit corporation” or “PBC”) is a for-profit legal structure, very similar to a C-corporation, with a stated focus on producing a public benefit (such as having a positive effect or reducing the negative effects on artistic, charitable, cultural, economic, or environmental interests), operating in a responsible and sustainable manner, and promoting transparency and accountability.
    • There are different filing and reporting requirements for forming and operating benefit corporations, and the requirements vary by state. If you are interested in setting up a benefit corporation or converting an existing company to a benefit corporation, make sure to check your state website to learn about the process and the ongoing requirements. 
    • Benefit corporations are often confused with Certified B Corporations (also called “B-corps”). Certified B Corporations are certified by the private nonprofit organization B Lab to meet certain standards of social and environmental impact, accountability, and transparency. The Certified B Corporation certification is a private certification. The process and requirements are described on the B Lab website.
    • There is no change to the C-corporation tax treatment for benefit corporations or Certified B corporations.
  • Nonprofit Corporations
    • Nonprofit organizations are very similar to C-corporations, with a stated mission to pursue a charitable, educational, religious, literary, or scientific purpose. 
      • Nonprofits are exempt from paying taxes on certain business income and business owners must register with the IRS to obtain tax-exempt status for the company. 
      • Nonprofits are subject to many different tax, accounting, and operational requirements and they must operate carefully to preserve their tax-exempt status. If you choose to form a nonprofit corporation, you should consult with qualified legal and tax professionals to understand all of your obligations.