Overview of a Close Corporation

Overview of a Close Corporation

by Belle Wong, J.D., November 2018

If you've determined that the corporate structure is the best entity for your small business endeavor, a close corporation may be worth considering. Such business structures offer many of the advantages of incorporation while negating some of the disadvantages of the regular corporate structure.

Close Corporation vs. Statutory Close Corporation

While the term "close corporation" refers to any corporation that isn't publicly traded, a statutory close corporation is a business entity that is created solely by state laws. The purpose of a statutory close corporation is to provide small business owners with the advantages of incorporation without some of the more onerous corporate governance requirements. For example, depending on your state of incorporation, your statutory close corporation may not need to file an annual report or have a board of directors.

Not all states offer the ability to register as a close corporation, so if you're interested in using this structure for your business, research the law specific to the state in which you intend to incorporate.

Close Corporation vs. Partnership

One of the benefits of registering your business as a close corporation is that it can provide you with many of the advantages of operating your business like a partnership while also offering incorporation benefits such as limited liability. As in a partnership, a close corporation's shareholders are usually the owners or managers of the business. There are also restrictions on how shares within the close corporation can be transferred, much like the restrictions imposed on transferring a share in a partnership.

Close Corporation vs. Corporation

As mentioned above, a statutory close corporation offers the small business owner many of the advantages of the corporate structure while at the same time dispensing with the need to adhere to certain corporate formalities. The specifics of how a statutory close corporation must be structured and operated vary from state to state, but most state laws require that the articles of incorporation contain a clause electing that the business be registered as a close corporation.

Close Corporation Shareholder Agreement

Many states also require a statutory close corporation to operate in accordance with a detailed shareholder agreement. Due to the level of detail that might be required, a close corporation might be initially more costly to set up than a regular corporation, but this cost is often offset by the reduced need to comply with annual compliance filings.

For example, comprehensive buy-sell wording is one area typically required to be covered within a close corporation agreement, as restrictions on the transfer of shares is generally one of the requirements of registration as a close corporation. Given the level of detail required, it's often advisable to retain the services of an attorney experienced in the formation of statutory close corporations in your state to assist in the drafting of the close corporation shareholder agreement.

Close Corporation Taxation

Like any corporate entity, your statutory close corporation has the option of electing to be taxed as an S corporation, a corporate taxation status that is relevant only when it comes to federal taxes. If your close corporation does not elect S corp. status, then it is taxed as a C corporation, the regular taxation status for corporations.

While a C corp. must file its own tax return, S corp. status allows corporations to "pass through" its income and expenses to the corporation's owners. That means that an S corporation's income is reported on shareholders' personal tax returns, rather than on the company's tax return. Because of this, many small business corporations find it more advantageous from a tax perspective to elect to be taxed as an S corp.

For many small businesses, the regular corporate structure can be more onerous because of the many corporate governance requirements that must be complied with. If you're in the process of forming your corporation, it might be advantageous to register your new corporation as a close corporation, provided the state in which you are incorporating offers the option to do so.