When most people think of a corporation they think of companies with a lot of power and wealth. Although this is true, any company can be a corporation with a bit of work.
Corporations are legal entities that are separate and distinct from their owners. When forming a corporation, your business may enjoy most of the rights and responsibilities that individuals possess. These include obtaining loans, borrowing money, being sued, suing other people or companies, hiring employees, owning assets, entering contracts, and even paying taxes.
But how do corporations work, and should you start a corporation?
How Corporations Work
Corporations are owned by their shareholders. Each shareholder will own one portion of the corporation in a number of shares. Some corporations have many owners, while some have only a few.
Corporations are taxed separately from their owners at the corporate tax rate which is 8.7% in Delaware at the state level, and 21% federally. Corporations always pay taxes based on net income or profits. They are separate tax entities.
Starting a corporation is not incredibly difficult, but does require a few specific steps including filing Articles of Incorporation, Adopting Bylaws, and recording Org Minutes. These strict requirements can often be one reason why businesses avoid incorporation.
Why Start a Corporation?
There are various reasons why you may want to start a corporation. The first is that it provides an air of professionalism. Instead of being a single person or group of people working on a business, you have a title and corporation behind you. The next reason is for taxes. Corporations are taxed at a flat level of 21%, which is often much lower than that of the owner’s personal income tax rates.
Corporations are also afforded Limited Liability. This means if something happens in business, the owners are not liable. Whether that is for the debts of the company or a lawsuit, this is essential for any business owner or investor.
Finally, forming a corporation offers privacy. Not every corporation is formed anonymously, but it is possible. When formed anonymously it will allow you to protect your identity and avoid ties to the corporation or its mission.
Different Types of Corporations
There are three main types of corporations in how you can form. Two of these types are for-profit (S corp and standard c corporation), while you can also form a non-profit corporation.
Forming as a c corp is essential just forming as a standard corporation. Although C corps are taxed at the federal corporate tax rate, they also have a unique issue called “double taxation.” Double taxation is when a corporation is taxed on its profits, but then the shareholders of the corporation are also taxed on their individual income. Corporations may also not claim a deduction for any profits passed on to shareholders.
Shares held completely by religious organizations, in retirement accounts, or by education institutions are considered non profit corporations. Because of this, they are not subject to any level of taxation. All of the profits generated by the company may be used for any purpose that helps to propel the business. This includes salaries of employees or funding to generate profits.
Because the S Corps avoid double taxation, they also have numerous requirements to reap these advantages.
- S corps must be domestic corporations.
- They can't have more than 100 shareholders.
- Shareholders must be individuals, trusts, or estates.
- Partnerships, other corporations, and non-resident alien shareholders will not qualify as shareholders.
- S corps can have only one class of stock.
Advantages of a Corporation
Here are 3 key benefits of starting a corporation in Delaware.
- Separate legal entity: When forming a corporation it is its own entity, meaning it can purchase real estate, enter contracts, and do a variety of other activities that a single person has the right to do as well.
- Limited liability: The debts and liabilities of corporations are completely separate from those of the owners. This is often called a "corporate shield" because it protects both employees and shareholders from liability.
- Easier to attract investors: By operating under the name of a corporation it is easier to attract investors. Especially because many corporations are publicly traded, meaning they allow anyone to purchase stock in the company at any time. This is an easy way to raise capital.
Disadvantages of a Corporation
Although there are many reasons to start a corporation in Delaware, there are a few disadvantages.
- Maintenance is Difficult: There is a lot that goes into a corporation versus forming an LLC. This means that instead of simply filing an annual report each year, there are various other maintenance tasks that can be tedious.
- Start-up costs: It can be expensive to go through the process of incorporation versus forming a sole proprietorship or partnership.
- Potential Double Taxation: When forming as a c corp, there is the potential for double taxation which can majorly cut into the profits of the overall business.
- Reporting to State, Investors, IRS: Not only is there a requirement for incorporation documents, but companies must file annual reports and tax returns. They are also required to maintain accounting records, licenses, and various other documents.
Should You Start a Corporation?
The main reason for forming a corporation is to limit the liability of the owners. If there are a number of owners in a business, a corporation can protect their interests and keep them separate from the business. This way the shareholders will not be liable for the debts and liabilities of the business.
Corporations can be good for those who already make a large income, and are looking to avoid being taxed in that income bracket. Instead, they can only be taxed at the 21% corporate tax rate. They also have a lot of structure built into them, which is good for those who are large and have a lot of moving pieces.
Get help starting a Delaware Corporation
Due to corporations being a bit more complex than that of an LLC, it is recommended to seek assistance during formation. This can either be done by a lawyer, or business firm such as a registered agent.