Corporations: Choosing the Right Business Structure

This blog is part 3 of a series exploring various business structures and what makes each structure unique. Specifically, it will examine the characteristics of corporations. Sole proprietorships, business partnerships, limited liability companies, and joint ventures are covered in separate blogs.

As an owner, you may have wondered at some point if the business structure currently in place was the right choice. Those looking to start a business have probably wondered about which structure would best fit their needs as well. Determining the right structure for your circumstances can lead to better performance and higher returns down the line. For example, shifting to a more complex framework than your business’s current structure could allow you to take advantage of certain legal protections or tax options. It could also help generate a higher valuation, depending on the state of your business’ operations. Ultimately, the decision depends on the type of business you are running, its size, and your goals for the business.

Corporations

Corporations are a relatively complex structure in which the business is legally separate from its owners – the shareholders – meaning it can be taxed and held legally liable for its actions. This protects the owner(s) against personal liability for the debts of the corporation. On the other hand, corporations must comply with more stringent regulations and tax requirements as a result, which could potentially drive up advisory costs.

Unlike sole proprietorships and partnerships, corporations are not necessarily run by ownership; rather, business decisions are made by the board of directors, whose members are elected by the company’s shareholding body.[1] Board membership may include, but is not limited to, those who hold shares in the company. A smaller, private corporation’s board may comprise of a small group of shareholders, including the pre-incorporation owner. Larger public corporations may choose a rotating cast of members that include internal directors (such as major shareholders) and external members (such as outside experts).

As hinted at in previous blogs on business structures, corporations are treated differently under the tax code than are sole proprietorships and partnerships. Corporations are formed under the laws of each state and are subject to corporate income tax at the federal and generally at the state level. Corporate tax rates are variable across states and over time.[2] In addition, any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal tax returns.

A corporation’s type, of which there are two, has tax implications as well.[3] Companies registered as the first type are called C corporations because the corresponding tax rates can be found in Subchapter C of Chapter 1 of the Internal Revenue Code. If a shareholder is an employee, he pays income tax on his wages, and the corporation and the employee each pay one half of the social security and Medicare taxes and the corporation can deduct its half. A corporate shareholder pays only income tax for any dividends received. This leads to the phenomenon of double taxation, where the same dollars that were taxed as part of a corporation’s income are taxed as shareholders’ personal income.

The S corporation is a variation of the standard corporation that allows income or losses to be passed through to individual tax returns (i.e. pass-through entity). The rules for S corporations are found in Subchapter S of Chapter 1 of the Internal Revenue Code. An S corporation has the same corporate structure as a standard corporation. The primary difference is that the corporation files an election to be treated as a pass-through entity, which exempts it from most federal income taxes – thereby mitigating the issue of double taxation. However, S corporations are limited to no more than 100 shareholders, all of whom must be U.S. citizens or residents.

Despite its comparative complexity, the corporate business structure offers various tax advantages.[4] For example, corporate income is not subject to social security, workers compensation, or Medicare taxes. In addition, corporations can defer the taxes they pay through methods such as accelerated depreciation.

Certain business structures may be more appealing than others in various situations. Making the determination of whether your business’s current structure best fits your circumstances and goals is an important element of strategic planning. However, this can be a complex, multifaceted process.

Fortunately, Kaulkin Ginsberg can help you navigate those choppy waters. We have worked with small, mid-sized, and large privately-owned companies, Fortune 500 corporations, and financial investment firms on their mergers and acquisition (M&A) strategies for thirty years. Whether you’re seeking professional sell-side representation, assistance forming a partnership or joint venture, a transaction assessment, or a valuation, Kaulkin Ginsberg will guide you through the process. For more information, or to schedule a confidential discussion of your business goals, contact us here or at hq@kaulkin.com.

Works Cited

[1] Chen, James. “Board of Directors (B of D).” Investopedia, 12 April 2021 https://www.investopedia.com/terms/b/boardofdirectors.asp.

[2] “The State of State (and Local) Tax Policy.” Tax Policy Center, 2019, https://www.taxpolicycenter.org/briefing-book/how-do-state-and-local-corporate-income-taxes-work.

[3] “Forming a Corporation.” Internal Revenue Service, https://www.irs.gov/businesses/small-businesses-self-employed/forming-a-corporation.

[4] “7 Tax Advantages Of Incorporating Your Business.” Corporate Direct, 23 May 2019 https://www.corporatedirect.com/blog/tax-advantages-of-incorporating-your-business/.

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