A closely held corporation has a number of advantages and disadvantages for the small business owner. But is it the right structure for your business?
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by Belle Wong, J.D.
Belle Wong, is a freelance writer specializing in small business, personal finance, banking, and tech/SAAS. She ...
Updated on: January 17, 2023 · 4 min read
Although incorporated small businesses are often referred to as closely held corporations, the term isn't a legal one. A corporation is considered to be closely held if it has a small number of shareholders, or owners, as compared to a widely held corporation, which has a large number of shareholders.
Closely held corporations are private corporations, which means that their shares are not listed on public stock exchanges. As mentioned above, there is no standard legal definition of a closely held corporation, although the term itself may be defined in various state and federal statutes.
A publicly held corporation, on the other hand, has shares available for sale on different public stock exchanges. Because of this, the shares of a publicly held corporation can be purchased by any individual interested in investing in the company.
The nature of a closely held corporation offers several advantages, including:
Despite the above benefits, a closely held corporation also has some drawbacks, including:
Like any other corporate entity, if a closely held corporation meets IRS conditions for S-Corporation status, it can elect to be taxed as an S-Corp. by filing Election by a Small Business Corporation (Form 2553). If you do not make this election, the corporation is taxed as a C-Corporation.
However, it's important to note that the IRS does offer a definition of a closely held corporation: a corporation, that is not a personal service corporation, where five or fewer individuals own more than 50 percent of its shares. While not a standard legal definition, it does set out the criteria the IRS uses to assess whether it considers your corporation to be closely held or not.
A corporation that falls within this general definition and that is taxed as a C-Corporation is subject to additional tax rules. If this is the case for your closely held corporation, it's advisable to consult with a tax adviser to see how these additional rules might affect you.
Taxation as a C-Corp. also requires you to consider how you distribute income from your corporation, such as through dividends. However, dividends from closely held corporations often come with double taxation issues, as corporations cannot take a deduction for dividends, which are also taxed at the shareholder level.
For the small business owner, there are many advantages of being a closely held corporation, including the ability to exercise greater control over the corporation's management. There are also, however, a number of disadvantages. As you embark on the process of forming your new company, a careful assessment of these pros and cons can prove beneficial.
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