UNDERSTANDING THE AVAILABLE BUSINESS STRUCTURES 

  1. What is a Corporation?

 

A corporation is a legal entity established by individual(s) under the laws of a state to conduct particular types of business or transactions. The corporation exists separately from its shareholders, directors and employees. A corporation is legally treated as an individual ‘person’. A corporation functions in the same manner as a person and has the same rights and responsibilities as a person. The corporation may make contracts, file applications to register trademarks and copyrights and for issuance of patent grants,  assume liabilities, sue and be sued. The corporation and its shareholders and directors have specific duties and obligations to each other.

A Maine corporation may engage in business for any lawful business unless a more limited purpose is set forth in the Articles of Incorporation. It is not required that the purpose or purposes of the Maine corporation be set forth in the Articles of Incorporation.  A corporation is formed for the purpose of transacting business in the broadest sense of the word, and these transactions are conducted to return a profit.

  1. C Corporations and Subchapter S Corporations.

 

(1)  C Corporations. All Maine corporations formed by default are “C” corporations. A Maine C Corporation is a Maine corporation that has not made an election to be an “S” corporation. The term C Corporation is specifically used because the entity is taxed under subsection C of the IRS code. Maine C corporations are taxed at two levels (“double taxation”). This means that the corporation itself pays its own tax when it makes money (the first tax). The owners or shareholders are then taxed again when they are paid a salary or dividend by the corporation (the second tax). Despite double taxation, Maine C corporations offer many planning and benefit opportunities.  Most major companies (and many smaller companies) are treated as C corporations for U.S. federal income tax purposes.

(2).  S Corporations:  Subchapter S (a.k.a. “Small”) Corporations.  It is very important to understand that a S corporation is first and foremost a corporation.  That means that it must observe all the corporate formalities imposed by the Maine corporations statute, including registration with the Maine Secretary of State as is the case with a C Corporation.  A Subchapter S corporation is a form of corporation that meets specific Internal Revenue Code requirements. The requirements gives a corporation with 100 shareholders, or less, the benefit of incorporation while being taxed as a partnership. The corporation may pass income directly to shareholders and avoid double taxation. Requirements include being a domestic corporation, not having more than 100 shareholders which include only eligible shareholders, and having only one class of stock.

(3).  Advantages of a C Corporation

(a).  Limited liability. This applies to directors, officers, shareholders, and employees. Perpetual existence. Even if the owner leaves the company.

(b).   Enhanced credibility. Gain respect among suppliers and lenders.

(c).   No Limit on Number of Shareholders. However, once the company has $10 million in assets and 500 shareholders, it is required to register with the Securities Exchange Commission (SEC).

(e).  Certain Tax Advantages. Certain business expense deductions.

 

(4). Advantages of a S Corporation .

(a).  Double Taxation.  Revenue is taxed at the corporate level and again on the shareholder as dividends.

(b).  Cost of Formation.  There are a lot of fees that come with filing the Articles of Incorporation, and fees paid to the state in which the corporation operates.

(c).  Regulations and Formalities. More government oversight than other companies due to complex tax rules and the protection provided to corporate owners from being responsible for debts, lawsuits, and other financial obligations.

(d).  No deduction of corporate losses. Unlike an S Corporation shareholders of a C Corporation cannot deduct losses on their personal tax returns.

(e).  Losses. Losses of a C corporation may offset only the corporation’s earnings.

  1. Advantages of a S Corporation.

(a).  Asset Protection.  All corporations, regardless of their tax status, provide the owners (shareholders) with limited liability protection. This means that the owners’ personal assets are shielded from the claims of business creditors, whether the claims arise from contracts or litigation.

 

(b).  Pass-through Taxation. A S Corporation is a pass-through entity for federal and Maine income tax purposes. Business income and many tax deductions, credits, and losses, are passed through to the owners, rather than being taxed at the corporate level.  While conventional wisdom views the following as advantages that an S Corporation offers its owners, it is important to realize that what is generally an advantage could be a disadvantage in some cases. For example, pass-through taxation generally is positive, but if you want to accumulate money for expansion or to build a new facility, a C Corporation might be the better choice because income can be retained within the corporation.

(c).  Salary and Dividend Payments. An S corporation owner can opt to receive both a salary and dividend payments from the corporation. This can result in an overall lower tax bill because dividends are not subject to self-employment tax. Moreover, the corporation can deduct the cost of the wages paid when computing the amount of income that is passed through to the shareholders, provided that this division is “reasonable” as determined by the IRS.

(e).  Ease of Conversion to a C Corporation. Because the only difference between an S corporation and a C corporation is how it is taxed if the shareholders want to be taxed as a C corporation they only have to make a filing with the IRS. An LLC that is taxed as a pass-through but wants to be taxed as a C corporation also merely has to make a filing with the IRS.

(f).  Loss Deductions.  Shareholders generally may deduct their share of the corporation’s net operating loss on their individual tax returns in the year the loss occurs.

(g).  Self-employment Tax Savings.  Only the earnings actually paid out to you as salary are subject to payroll taxes.  Money left in the business is not subject to payroll taxes or self-employment tax. All income passes through, but its tax status depends on whether it is classified as salary or ordinary income.

  1. Disadvantages of an S Corporation.

(a).  Strict Qualification Requirements. In order to be eligible to make an S Corporation election and to continue to be an S corporation, the corporation must meet strict requirements on number and type of shareholders and types of shares. These rules are imposed by federal tax law, and not state corporation law. Briefly stated, these rules include:

(b).  Availability.   Only individuals, certain estates and trusts, and certain tax-exempt organizations can be shareholders.  Partnerships, corporations, and nonresident aliens do not qualify as shareholders. Also, specific financial institutions, insurance companies, and domestic international sales companies are ineligible.

(c).  Limitation on Shareholders.  There cannot be more than 100 shareholders, although some family members can be counted as a single shareholder.

(d).  Limitations on Stock.  There can only be one class of stock, although differences in voting rights are permitted.

(e).  Rigid Profit and Loss Allocation.  Because it is a corporation, an S Corporation is required to allocate profits and losses among the owners based strictly on the percentage of ownership or number of shares held.