When we are talking about business structures, it is important to remember that there are two concepts you must keep straight: 1) the type of entity (or the legal reality) and 2) the IRS’ treatment of the entity. The first is a question of state law, the second is a question or IRS regulations and US tax law.
Legal Reality of a Corporation. A corporation is an entity that is distinct from its owners. It is formed by the filing of the appropriate paperwork with the State. The corporation may enter into contracts, sue and be sued in court, employ people, own property, and outlive its owner(s). The owners of the corporation are called shareholders. North Carolina allows for the existence of a corporation that has only one shareholder (some states set the minimum number at 2 or 3), but there is no restriction on the maximum number of shareholders. The shareholder(s) may exercise daily control of the corporation or they may delegate that to officers. A shareholder’s authority over the corporation and rights relative to the corporation and to other shareholders is governed by the Shareholder’s Agreement, if there is one (and there absolutely should be if there is more than one shareholder), or by state law if there is not.
In North Carolina, if you operate under an assumed name (i.e., any name other than the name of the Corporation) you are required to register your assumed name (called a d/b/a) in the Office of the Register of Deeds in every county in which you do business.
Advantages. Corporations can go public. An LLC cannot, neither can a partnership. Venture capital companies, therefore, prefer to work with corporations. So if you are considering seeking venture capital or, for that matter, other third-party investors (as opposed to family members, etc.) that will not be involved in the company on a daily basis, a corporation may well be the way to go.
Corporations also allow for financial structures whereby owners are not immediately taxed on profits so long as the profits remain in the corporation (rather than being paid to shareholders). An LLC may elect to be taxed as a corporation and then retain earnings, but the corporate form allows for more complex structures.
Corporations provide for protection of the owner’s personal assets from claims against the corporation. (Sole proprietorships and Partnerships provide NO such protection.) This means that if an employee commits a tort, and there is a lawsuit, the corporation may be liable but generally the owner(s) will not be personally liable. The injured party or a creditor can pursue the corporation but not the owner(s) personally. But you should know that there are some major exceptions to this. For more information about this, see “When Am I Personally Liable For My Corporation or LLC?”. It should be noted that, contrary to popular myth, all other things being equal a corporation provides no more liability protection than would an LLC. (Frequently all other things are not equal—have I mentioned the value of talking to an attorney about your specifics?)
Corporations have been around much longer than LLCs. This leads to two advantages: the body of case law governing corporations is more developed in most states, and is more uniform between states. This may be an advantage if operating across state lines.
Disadvantages. The formalities required to maintain the corporation (and its validity), the observance of which are necessary for both tax purposes and liability protection, are much more involved and complex for a corporation than for an LLC. While you may file Articles of Incorporation with the State and sail off into the sunset, doing so will probably result in eventual tax problems and will certainly result in a virtual absence of liability protection if you are sued down the road.
The accounting requirements and tax filings for a corporation are more detailed and complex than for an LLC (or sole-proprietorship) and are generally beyond the abilities of the untrained. So there will be accounting costs.
Tax Treatment. Since a corporation is an entity distinct from its owners, the corporation must file a tax return. The corporation pays taxes on its profits. The owners also pay tax (i.e., a further tax) on money they receive (dividends) from the corporation (hence the so-called “double-taxation”). The actual impact of this in a particular case is obviously very fact-sensitive—your mileage will vary. Filing for S-Corp status largely eliminates the “double-taxation”, but there are numerous strings attached to an S-Corp. See “What is an S-Corp?” for more information. If you are intending to form a corporation simply to seek S-Corp status for your business, you should carefully consider whether an LLC is a better fit. It may not be, but you should ask the question.
Corporations are the best choices in some situations. Feel free to contact us for a consultation where we can review your situation and discuss the specific pros and cons in your business.
As a further note: North Carolina law requires certain categories of licensed professionals to form a PC (which stands for Professional Corporation) rather than to incorporate under Chapter 55 if the purpose of the Corporation is to engage in the licensed profession. Virtually everything said here applies to a PC, but there are some additional ‘strings’ attached with which you must comply. See “What is a PC/PLLC?” for more information.