The Disadvantages of Forming a Corporation
Corporations offer a business many advantages, but there are also disadvantages that must be considered. These include loss of control of the business as it moves from privately owned to publicly owned; double taxation if the business is a C corporation; state-required filing fees, written bylaws, and various documents; and determination of and adherence to applicable rules and regulations. These disadvantages are discussed in greater detail below.
Distinct Legal Entity
If a business is your idea and passion in life, it is important to understand that you will not be the personal owner. A corporation is a distinct 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 simultaneously.
It is possible that even if you started the corporation, a board could take control of the business, thus leaving you without a say. A board often has the ability 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 consider another form of business structure.
Another disadvantage of forming a corporation is the double taxation requirement. 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 another option. Choose the Internal Revenue Service (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.
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 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.
Extensive 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.
Starting a business is a big commitment of time, resources, and money. Before deciding on the type of business to form, it is important to weigh all of the pros and cons of each business structure.