Disadvantages of Corporations
You have a lot of choices when it comes to picking a business entity and corporations are certainly one of them. In this article, we take a look at the disadvantages of corporations.
There is no perfect business entity. Each has its positives and negatives. The corporation is no different. The first disadvantage has to do with the formalities of running the entity. The corporation will protect you from liability, but only so long as it is seen to be a valid business. This means shares must be issued, officers must be elected, board of director positions must be filled and the board must hold at least annual meetings and maintain minutes in the corporate book. This isn't a huge nightmare, but it is a formality that must be complied with and most people view it as a form of red tape.
When it comes to disadvantages of corporations, the issue of double taxation is always brought up. What does it mean? Well, consider a profitable corporation. Let's say it makes $100,000 in profit this year and pays you $80,000 in salary as well. The corporation is going to be taxed on the $100,000. It may decided to distribute what is left in the form of a dividend. You are then going to have to pay tax on that dividend. You are also going to have to pay taxes on your salary. As a result, it is really a question of three levels of taxes. Contrast this with a sole proprietor who only pays once on their personal returns.
Now there are a couple of ways around this problem. The first is to simple expense out the profit by paying early for things you are going to need. You would be shocked to see how many corporations pay for most of the things they need for the next year every December. The other alternative is to simply declare as an “S” corporation for tax purposes. This has the effect of passing most of the finances of the corporation through to your personal taxes, which resolves much of the problem.
There is one other major potential drawback of the entity. If you do not follow the rules and regulations of your state for running it, a party suing you can try to “pierce the corporate veil”. This simply means they try to assert the corporation is a fraud and you should be personally liable for the debt in question. This is not an easy thing to prove. The lawyers have to show far more than you just did one or two things wrong. They usually have to show that the corporation was run as a personal play thing and that there was fraud involved. Again, the specific requirements vary by state. This is also why getting a corporate “check up” every few years with a lawyer is smart. They can correct any errors you are making and make sure the entity will stand up to any attack.
There are definite disadvantages to corporations as you can see from the above. Most of them, however, can be countered by a bit of planning.