Distinct Legal Entity
If your company is your idea and passion in life, it’s important to understand that you won’t be the sole owner. The company is an independent legal entity governed by a board of directors.
It’s possible that even if you are the one who started the company, the board can take over the business, leaving you without a say in the matter. The board often has the power to remove the founder and dismiss other board members.
Note: There are federal and state rules and regulations that determine who can be a board member. In most cases, family members and spouses cannot be board members of a small business at the same time. If you need to maintain full control of your business, you should consider another form of business structure.
Double Taxation
Another drawback of forming a corporation is the requirement of double taxation. Corporations pay taxes on profits when distributing corporate income to owners (shareholders) as dividends. This is the first tax.
Shareholders receiving dividends must also pay taxes on this distribution on their personal returns. This is the second tax on the same amount.
Note: There is another option for incorporation. You can form an S corporation to avoid double taxation.
Formation Costs
There are several filing fees associated with forming a corporation. Formation fees can vary from state to state, ranging from $45 to $315.
Note: In most states, corporations are also required to file annual documents and/or pay a franchise tax. Non-profit organizations usually must also pay fees to register their charitable organization annually.
Non-profit organizations must submit more paperwork as they need to apply to the Internal Revenue Service (minimum $750 for filing). In some states, non-profits may also need to submit a separate application for state tax-exempt status. Even small fees can add up if you are experiencing financial constraints.
Complexity in Formation
Corporations must file Articles of Incorporation with the state in which they are incorporated, which incurs various filing fees. They may also need to file bylaws, which may require the assistance of an attorney to draft.
Note: Many entrepreneurs file all their paperwork themselves. However, if you are new to business, you should at least consult a business attorney before attempting to form a corporation on your own.
Complex Rules to Follow
There are numerous legal requirements regarding how a corporation must be governed. Corporations must have a board of directors, hold meetings at specified intervals, and maintain certain records. If the corporation sells stock or has memberships, there are many other rules that apply.
Starting a business is a significant commitment of time, resources, and money. Before deciding on the type of corporation to form, it is important to assess all the pros and cons of each business structure.
Frequently Asked Questions (FAQs)
What are the benefits of forming a corporation?
Some benefits of forming a corporation include limited liability, ease of raising capital, and protection of the business name.
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Sources:
IRS. “Incorporating a Business.”
IRS. “S Corporations.”
Wolters Kluwer. “Business Incorporation Fees by State.”
U.S. Chamber. “6 Steps to Incorporate Your Business.”
Source: https://www.thebalancemoney.com/disadvantages-of-forming-a-corporation-3514957
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