Learn About the Disadvantages of Forming a Corporation

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Corporations offer a business many advantages, but there are also disadvantages that must be considered.

Double Taxation

C corporations pay taxes on profits when corporate income is distributed to owners (shareholders) in the form of dividends. This is the first taxation.

The shareholders who receive dividends must also pay taxes for this distribution on their personal returns. This is the second taxation of the same money.

The corporation itself does not pay taxes twice, but just the sound of “double taxation” can make potential business owners cringe. However, there is an out. Choose the IRS’ "S Corporation" tax status to avoid double taxation.

Expensive to Form

There are many filing fees associated with forming a corporation. Nonprofits must file even more paperwork because they must apply to the IRS for tax exemption status (minimum $750 to apply). In a few states, nonprofits may also have to file separately for state tax exemption status. Even small fees can add up if you are cash-strapped already.

Corporations Can be Complicated to Form

Corporations must file Articles of Incorporation with the state they are incorporating in for which states charge different filing fees. They may also need to file ​bylaws, which may require the help of an attorney to write.

Most states also require corporations to file annual documents and/or franchise tax fees. Nonprofits typically also have to pay fees for registering their charity each year.

Although many entrepreneurs do file all their own paperwork, if you are new to business you should at least consult with a business attorney before attempting to form a corporation on your own.

Lots of Rules to Follow

There are many standards required by law on how a corporation governs itself. Corporations must have a board of directors, hold meetings at determined intervals, and keep certain records. If a corporation sells stock or has a membership, there are many other rules that apply.

The Number One Disadvantage of Forming a Corporation

If your business is your idea and your passion in life, it is important to understand that you cannot personally own a corporation. The corporation is its own legal entity that is governed by a board of directors.

There are federal and state rules and regulations that dictate who can serve on a board of directors. In most cases, family members and spouses cannot serve on a small corporation’s board at the same time.

It is possible, that even if you started the corporation, a board could take control of the business and leave you out in the cold. A board often has the power to fire (even the founder) and to vote other board members off the board.

If you need to maintain total control of your business you should give first consideration to another form of business structure.

Starting a business is a big commitment of time, resources, and money. Before deciding upon the type of business to form, it is important to weigh all the pros and cons of each business structure.