Close Corporation Tax: Everything You Need to Know
It is something that the potential business owner should be aware of, as it not only differs from other types of corporations.3 min read
Close Corporation tax is something that the potential business owner should be aware of, as it not only differs from other types of corporations, but can vary significantly from state to state.
What Is a Close Corporation?
A close corporation is one that is not traded publicly and held by a limited number of shareholders. The company is exempt from many of the restrictions required of other types of corporations, including mandatory annual shareholder meetings and a board of directors. The close corporation is generally focused less on taxation and corporate formalities. This close corporation business structure can be referred to by several other names, including private company, privately held company, incorporated partnership, or family corporation.
Close Corporation Examples
Close corporations exist globally, with over 400 in the United States alone. They cover a large spectrum of industries from retail and manufacturing, to business services and financial services. The largest, according to Forbes in 2017, is the agricultural trade and distribution conglomerate, Cargill, Inc. In 2017, they reported earnings of over $100 billion and employed a staff of over 150,000.
Other examples of large US-based close corporations include:
- Koch Industries, Inc.: Globally involved in multiple industries, earned a revenue of over $100 billion in 2017.
- Albertsons Companies LLC: Reported income of over $60 billion in 2017 as the second-largest supermarket chain in the United States.
- Mars, Inc.: A global food product manufacturer, earned approximately $35 billion in 2017.
Close Corporation Formation
Not every state allows close corporations, but for those that do, it may be a viable option when the business is run by family members, when the owners prefer not to make disclosures publicly about activities or earnings, or when the principals would prefer to not take the company public. It is important to be educated on your individual state's statutes, as each state's requirements for close corporations can vary.
The most sensible business format is an important factor to consider when starting a business – it affects the organizational structure, taxation, and personal liability for company finances within your business. Choosing a corporation can offer the advantage of protecting you from liabilities involved with a sole proprietorship or partnership. While both well-suited for small businesses, close corporations and S corporations have some important differences.
Since they are formed on the federal level, in order to qualify as an S corporation, Internal Revenue Service form 2553 must be completed and submitted to the IRS. Since close corporations, on the other hand, are maintained at the state level, the IRS is not involved in their formation.
S Corporation vs. Close Corporation
An advantage of an S corporation is that all of the shareholders report earnings and losses as part of their individual tax returns, thus avoiding corporate taxation. A close corporation is unable to avoid corporate taxation, and in some cases, may receive double-taxation on personal and corporate tax returns.
The maximum number of shareholders differs between S corporations and close corporations. An S corporation is allowed no more than 100 shareholders, according to the Internal Revenue Code. The maximum number for close corporations is usually around 30 to 35 shareholders each but varies by state.
Tax Considerations of Close Corporation Buy/Sell Agreements
A buy/sell agreement is a protocol to maintain order during a planned transfer of a closely held business and prevents owners from transferring their ownership interests freely. There are taxation and non-taxation factors that may contribute to owners wanting to implement a buy/sell agreement.
Within a closely held corporation, the buy/sell agreement is a contract that is either between the shareholders or between the shareholders and the corporation. This contract dictates that a shareholder's stock will be sold to either the close corporation itself or to the other shareholders during the occurrence of a specific event that has been agreed upon contractually. Commonly. such events include retirement, disability, and death. However, personal bankruptcy, shareholder divorce, or the ability to perform one's profession can also be included as such contractual events. In the event that a shareholder wishes to sell his or her close corporation stock, a buy/sell agreement may also be created as a right of first refusal.
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