Advantages and Disadvantages of Establishing a Corporation

Advantages and Disadvantages of Establishing a Corporation

Decide how to form your business by reviewing the advantages and disadvantages of a corporation. Corporations are legal entities governed by federal and provincial law. In a corporation, stockholders maintain shares as proof of ownership. Usually, company executives control a sizable percentage of available shares.

Let’s take a closer look at corporations before exploring their advantages and disadvantages.

Corporations at a Glance

The two most common corporations are C corporations and S corporations.

C corporations must pay corporate income tax before paying dividends to shareholders. S corporations do not pay income taxes at the corporate level. Instead, the individual stakeholders pay taxes on corporate income based on their percentage share of the corporation. 

Apart from the two main ways to incorporate, you can also set up B corporations, non-profit corporations, and closed corporations. However, they are not as popular as S and C corporations.

Each type of corporation has its pros and cons. Let’s discuss the different types of corporations before reviewing their advantages and disadvantages.

Types of Corporations

Business owners who wish to incorporate have five main options: B corporations, C corporations, S corporations, non-profit corporations, and closed corporations. Learn more about each type below.

B Corporations

Also referred to as Certified Benefit Corporations, B corporations are for-profit organizations designed to benefit society. These corporations aim to improve social welfare and the environment.

S and C corporations can attain B corporation status by achieving scores of 80 or higher on the B Impact Assessment. B corporations also retain their C or S corporation status.  

C Corporations

As the most common form of corporation, C corporations do not require shareholders to pay taxes on income earned by the company. Instead, these corporations pay corporate income tax. Many large companies choose to become C corporations, but it is less common for smaller companies.

C corporations sell stock shares to raise capital and can have as many shareholders as the market will allow, making it a popular choice for large businesses.

S Corporations

S corporations provide similar advantages as C corporations. However, S corporations do not face double taxation the way C corporations do. In an S corporation, the shareholders shoulder the income tax responsibility for gains, losses, credits, or deductions. The corporation does not pay separate taxes.

Closed Corporations

Closed corporations are:

  •         Incorporated partnerships
  •         Private companies
  •         Family corporations

Only a few shareholders own these companies. These corporations also do not trade their shares publicly, which can make it hard to raise funds. Shareholders in closed corporations enjoy limited personal liabilities.

Non-profit Corporations

Non-profit corporations are organizations established for charitable, political, educational, or scientific purposes. Non-profit corporations cannot distribute their profits to shareholders or directors. However, they can pay wages and receive compensation for the services they offer. 

Organizations can approach federal and provincial governments to file for non-profit, tax-exempt status.

What You Need to Know About Corporations

If you own a small business, you can choose its legal structure. Do you want to maintain a sole proprietorship, form a Limited Liability Company (LLC), or file articles of incorporation for a C corporation?

In a corporation, shareholders can buy or sell stock to transfer ownership easily. A corporation can enter litigation independently, sometimes to protect shareholders from personal liabilities resulting from legal disputes.

Every province has laws to guide the formation of corporations. They often include procedural rules regarding the development of corporate bylaws and filing incorporation articles. Consider retaining the services of a tax advisor or attorney for advice regarding the formation of your corporation.

How Corporations Function

Due to their treatment as a separate legal entity, corporations protect shareholders’ personal assets from liability. In the vast majority of cases, corporations can carry out all legal business activities. Such activities include any action required for company operations, like:

  •         Purchasing assets
  •         Initiating legal proceedings
  •         Borrowing capital, executing contracts
  •         Recruiting new employees

The shareholders in a corporation elect a board of directors to guide the company forward. A shareholder receives one vote for every share they own. The board oversees daily business operations and may hire a management team to pursue company goals.

The ease with which shareholders can buy and sell shares makes the transfer of ownership a hassle-free process, which helps the business adapt and thrive over long periods.

Advantages of Establishing a Corporation

Other than easy ownership transfers, corporations also offer several other advantages, including:

  •         Protection from personal liability
  •         Added business continuity
  •         Periodic tax benefits
  •         Easy access to capital

Discover the advantages and disadvantages of a corporation below.

Personal Liability Protection

Out of all the different types of businesses that you can form, corporations offer the best protection against personal liability, especially for shareholders who hold C-level positions.

In the event of a legal dispute, the court cannot hold shareholders liable for the company’s actions without first going after the corporation. In fact, the protection of personal assets from liability entices many business owners to incorporate.

Business Continuity

Stock ownership percentages determine ownership in corporations. Compared to other entities, this system provides increased flexibility during a change of ownership, which helps maintain a company’s longevity. 

The terms agreed to in the articles of incorporation and bylaws decide the specifics of ownership transfers. Shareholders need to sell their stocks if they wish to relinquish ownership. In the event of a shareholder’s death, you can transfer their stock to natural heirs or other named parties.

Capital Access

Many corporations sell their stock to the public. It makes fundraising a relatively simple task if the company requires capital, an advantage that other business entities do not offer. This access to capital assists with the growth of a business and prevents bankruptcy during lean times.

Tax Benefits

Some corporation types, such as S corporations, do not pay corporate taxes. Instead, they divide their incomes among their shareholders as dividends, which the Canada Revenue Agency (CRA) taxes at a different rate. Stock dividends often get taxed as capital gains.

Disadvantages of Establishing a Corporation

Incorporation may not always represent the best solution for your business. In some cases, it may cost you valuable time and money. You need to understand the disadvantages of corporations before you decide to start one. Aside from the protracted application process, high cost, and rigid protocols, you may also end up doubly taxed by the CRA.

Extensive Application Process

The incorporation process often takes a long time, even if you quickly file the articles of incorporation. You will need to submit all of the details regarding your business, including its ownership. The process often means you will need to sift through lots of paperwork.

The necessary procedures include:

  •     Drafting and maintaining corporate bylaws
  •     Directorial board appointments
  •     Issuance of stock certificates
  •     Creation of ownership transfer agreements

Rigid Structure, Protocols, and Formalities

Adhering to complex legal requirements and maintaining your corporation requires a lot of time and energy.

As a primary owner, you must:

  •         Stick to your bylaws
  •         Organize annual meetings
  •         Support a directorial board
  •         Generate yearly reports
  •         And more

Some corporation types also face certain restrictions. For example, some corporations can only have a certain number of directors and must adhere to strict rules regarding citizenship.

Double Taxes

Executives of C corporations often face the problem of double taxation because the company’s income is subject to taxation at both the corporate and shareholder level. You can avoid paying double taxes when you establish an S corporation, but this means you can not go public.

High Costs

Establishing a corporation can cost quite a lot. Although a corporation can sell shares for funding purposes, the daily operations of a corporation also require significant capital. Larger tax bills, filing fees, and recurring charges only add to the overall cost. Business owners need to raise a lot of money before starting a corporation.

Schedule an appointment with an accountant or attorney to help you calculate the estimated cost of setting up a corporation. You can also ask for advice regarding which type of business entity suits your company best.

How to Solve Common Small Business Problems Effectively

Read about even more ways to streamline your business in our How to Solve Common Business Problems Effectively article.

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