A disadvantage of the corporate form of organization is

First, because the corporation itself has legal standing, it safeguards its owners, relieving them of individual legal responsibility when they act as agents of the business.

Second, the owners of shares of stock have limited liability; they are not responsible for corporate debts. If a shareholder paid $100 for 10 shares of stock and the corporation goes bankrupt, he or she can only lose the $100 invested.

Third, corporate stock is transferable. Thus, the corporation is not damaged by the death or disinterest of a particular person. An owner of stock can sell his or her holdings at any time or pass the stock along to heirs.

Yet the corporate business organization has drawbacks as well as benefits.

One disadvantage relates to taxation. As a separate legal entity, the corporation must pay taxes. Unlike the treatment of interest on bonds, dividends paid to shareholders are not a tax deductible business expense for the corporation. When the corporation passes along profits to individuals in the form of dividends, the individuals are taxed again on these dividends. This is known as "double taxation."

Another cost results from the fact that ownership becomes separated from management. While this makes management easier, some managers are tempted to act more in their own interests than those of the stockholders.

Organizing your business as a corporation offers many advantages, but there are also disadvantages that must be considered.

Sometimes, it is a double-edged sword. The attractive things about a corporation may also present a downside, depending on what your business is or how you would like to run it.

Key Takeaways

• The disadvantages of forming a corporation may depend on you and your goals for your company.
• Corporations have a board of directors, which can complicate decision making and can even result in you losing control of the company.
• Corporations can be expensive and complicated to form depending on the state you're organizing in.
• Forming a corporation could result in double taxation.

See the reasons in this article to determine if the downsides are worth the rewards of forming a corporation.

Distinct Legal Entity

If your business is your idea and passion in life, it is important to understand that you will not be the personal owner. A corporation is a distinct legal entity that is governed by a board of directors.

It is possible that even if you started the corporation, a board could take control of the business, leaving you without a say. A board often has the ability to fire the founder and vote other board members out.

Note

There are federal and state rules and regulations that dictate who can serve on a board of directors. In most cases, family members and spouses cannot serve on a small corporation’s board simultaneously.

If you need to maintain total control of your business, you should consider another form of business structure.

Double Taxation

Another disadvantage of forming a corporation is the double taxation requirement. C corporations pay taxes on profits when corporate income is distributed to owners (shareholders) in the form of dividends. This is the first taxation.

The shareholders who receive dividends must also pay taxes for this distribution on their personal returns. This is the second taxation of the same money.

Note

There is another option within incorporation. You can form an S Corporation tax status to avoid double taxation.

The corporation itself does not pay taxes twice, but just the sound of “double taxation” can make potential business owners cringe. However, there is another option. Choose the Internal Revenue Service (IRS) S Corporation tax status to avoid double taxation.

Expensive to Form

There are many filing fees associated with forming a corporation. Formation fees can vary state-to-state, ranging from as little as $45 to as high as $315.

Note

Most states also require corporations to file annual documents and/or franchise tax fees. Nonprofits typically also have to pay fees for registering their charity each year.

Nonprofits must file even more paperwork because they must apply to the IRS for tax exemption status (minimum $750 to apply). In a few states, nonprofits may also have to file separately for state tax exemption status. Even small fees can add up if you are cash-strapped already.

Complicated to Form

Corporations must file Articles of Incorporation with the state they are incorporating in, for which states charge different filing fees. They may also need to file ​bylaws, which may require the help of an attorney to write.

Note

Many entrepreneurs file all their own paperwork. However, if you are new to business, you should at least consult with a business attorney before attempting to form a corporation on your own.

Extensive Rules to Follow

There are many standards required by law on how a corporation governs itself. Corporations must have a board of directors, hold meetings at determined intervals, and keep certain records. If a corporation sells stock or has a membership, there are many other rules that apply.

Starting a business is a big commitment of time, resources, and money. Before deciding on the type of business to form, it is important to weigh all of the pros and cons of each business structure.

Frequently Asked Questions (FAQs)

What are the advantages of forming a corporation?

Some of the advantages of forming a corporation are limited liability, ease of raising money and business name protection.

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Sources

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

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