There are several different types of corporations that you can form in the United States, such as LLCs, S corporations, Limited Partnerships, and more. You also have the opportunity to create your business as a closely held corporation, as long as you meet specific criteria.
If your company does qualify, several different advantages come with this filing. So how does a closely held corporation work? Continue reading below to learn more about these corporations and who you can reach out to for more information.
What Is a Closely Held Corporation?
A closely held corporation, also known as a closed corporation, is when a business has a few people owning more than half of its stocks. Per the IRS, a closed corporation is a non-personal service corporation with 50% of its outstanding stock owned by five people at any point in the last six months of the tax year. Several different types of business corporations can be classified as closely held corporations.
Different business classifications for closed corporations:
- S corporation
- C corporation
Under the C corporation business classification, any losses or profits are the corporation’s responsibility. For any S corporation business, their losses and profits are passed through to the business owners.
Breaking Down Closed Held Corporations
There are different preferential tax treatments between significant shareholders and closely held corporations, despite the corporation’s stocks being listed. Any losses or deductions may not be allowed in certain circumstances for parties involved in those transactions.
A closed corporation is a firm with a small number of people who own stock. While these people may be investors, these stockholders can also be family members or others directly associated with the company.
To qualify as a publicly-traded, closed company, people outside of the corporation must have a certain number of shares. Shares in a closed company are called closely held shares.
The prices of shares in a closed corporation tend to be more stable than those often traded on the open market. This is because shares in a closed corporation do not get traded as often.
Although this may sound attractive, it may not be ideal since fewer shares are outstanding for public trading. These shares may also experience less liquidity, making them more volatile.
It is also important to note that the company’s founders set the share price for a closed corporation. It also is often calculated by dividing the amount raised by the number of shares issued or to be issued.
Many people will argue that there is less influence from irrational market activity on the price of these shares because trading is so limited. This helps prevent the business from being subject to uninformed average investors who can be very unpredictable. It is also challenging to properly estimate and value the closed corporation because of the lack of shares on the open market.
Most closed corporations are controlled by a small number of large shareholders because of their large hold on the majority of the shares in the company. These shareholders also maintain their investments for an extended period of time, resulting in few opportunities for any other possible investors to try to acquire a significant enough stake in the company.
So if someone new wishes to invest in a company that classifies as a closed corporation, there is a slim chance they can purchase enough stake to become a controlling member. Instead, they may only have access to minority stakes. These shareholders affect tax implications, transactions, and other controlling interest concerns.
Because the majority of the shareholders in the company rarely release or sell any of their shares, it makes it very challenging for any outside corporation or entity to attempt a hostile takeover. This is what makes the company more stable because all the decisions made on the company come from those who initially started or have an influence on the company. These decisions are also solely for the business’s interest, nothing else.
Publicly Held vs. Closely Held Companies
Compared to a publicly held company, a closely held corporation only has a few shareholders. As mentioned earlier, this small group of shareholders hold their shares for a long time and almost always have significant influence or control in the company.
Most closed corporations are private corporations with restrictions and who can own shares. With a publicly held company, they have many shareholders; therefore, they cannot restrict who can obtain these shares that are listed on public stock exchanges. Unless someone has a significant stake in a publicly held company, most shareholders have limited influence on business decisions and operations.
Pros and Cons of a Closely Held Corporation
There are many different benefits of a closed corporation. In general, those who run closely held companies are the shareholders who own a large majority of the company’s shares. Because of this, these shareholders have great control over decision-making and operations.
Where permitted, many closed corporations may have the opportunity to forgo filing information returns to the IRS each year. Additionally, closed corporations may qualify as S corporations for tax purposes. This allows any income from the business to be passed through to the owners or their shareholders, alleviating any tax burden from the corporation.
Control of the Company
As mentioned above, because a handful of people hold stock in the company, the decisions made for the company are made solely to benefit the company. This means that no outside investors can influence any big company decisions, creating greater control.
Closed Corporation Status
Closely held companies often have the ability to take advantage of statutory close corporations rules. It is important to note that not all states offer corporations to register as closed corporations.
Still, if yours does, you can obtain many benefits of a closely held corporation. This includes the ability to run your business without meeting certain corporate formalities.
Disadvantages of a Closely Held Corporation
Although there are several excellent benefits associated with incorporating as a closely held corporation, you should consider a few disadvantages. For example, one of the most significant disadvantages is how the closed company raises money to fund their business needs.
It is much more challenging to use share equity to raise funds needed for the company since the corporation’s shares are not listed on the public stock exchange. This makes it harder for outside investors to purchase stock in these types of companies. Instead, most closely held corporations reach their funding goals through capital contributions from the shareholders and any generated profits.
Individual shareholders may face many challenges if they wish to sell their shares in a closely held company. Not only are the shares not listed publicly, but the shareholder of agreements of most closely held corporations are very strict on the transfer of shares.
Although closely held corporations only have a few shareholders in the company, they still have a fiduciary duty. This means those who manage and control the company are still held to a high standard of duty. The legal term refers to the obligation the managers have to make decisions in the company’s best interest instead of their own personal interests.
Taxes on Closely Held Corporations
Like any other corporate entity, if a closely held corporation meets IRS conditions to be an S corporation, they can elect to have their business taxed as an S corp. If they do not make the election, their business will be taxed as a C corporation.
Any corporations that fall within the definition of a closely held corporation taxed as a C corporation are also subject to additional tax rules. If this is the current situation for your company, it would be best to reach out to a tax adviser to see how these other tax rules affect your business.
Taxing as a C Corporation
Taxing your company as a C corporation requires you to consider how you plan to distribute income which you can do through dividends. It is important to note that dividends from closely held corporations can run into double taxation issues because corporations cannot take deductions on dividends. Dividends are taxed at the personal income level of each shareholder.
LLC vs. Closely Held Corporations
Most LLCs are closely held corporations when they act as partnerships, but each state has its own rules for what constitutes an LLC and a closely held corporation. LLC owners are not responsible for the company’s liabilities and debts, and any of the losses and profits pass through to the business owners. This is similar to how income is passed through to shareholders in closed companies.
States That Allow Closed Corporations
As mentioned earlier, a few states allow companies to file as closed corporations. A few states that allow you to file are Alabama, Arizona, and Delaware.
Other states allowing closed corporations:
- District of Columbia
- South Carolina
There is still hope if the state you wish to incorporate in as a closed company is not listed above. You can form the entity in one of the states that allow closed corporations and then register the entity in your home state.
Keep in mind that if you are unfamiliar with filing the business in a different state, you will want to reach out to a tax professional. They will ensure that you file correctly and don’t run into any issues.
Finding a Tax Professional
When forming your closely held corporation, you will want to make sure that you enlist the help of a tax professional. As mentioned earlier, if your company meets the criteria to be taxed as an S corporation, you can elect to have your business taxed as so.
Many closely held companies opt for this option because of the many benefits. For example, S corporations are exempt from federal income tax other than taxes on certain passive incomes and capital gains. If you are unsure if your business qualifies, you can always reach out to a reputable tax professional to help you file your company as an S corp.
Check for Licensure and Experience
When choosing a tax advisor for your business, make sure that you check for their licenses. Most reputable, certified public accountants (CPAs) or tax attorneys have the proper certifications to handle your company’s taxes.
It would also be best to ask if they e-file their returns. The IRS requires all paid tax preparers to file their returns electronically if they handle more than ten returns a year. If the person you work with only handles paper returns, then they may not have the tax preparation expertise you need for your business.
It is essential to check the availability of your tax preparer. If they are only available during tax time, you should look elsewhere. If your returns get audited, you want to be able to count on your tax professional to have your back.
Compare Different Tax Advisor Fees
It is important to note that not all tax professionals charge the same price for their services. For example, tax attorneys can also help file and prepare your taxes, but they tend to charge more than a CPA.
Most attorneys charge thousands of dollars to handle your paperwork. Some charge flat rate fees, whereas others charge you per hour. Once you find a few tax professionals that charge reasonably, be sure to compare their fees before you make your final selection.
Closely Held Corporation Tax Help
Filing taxes on your own personal income may be an easier feat than filing when your business is classified as a closely held corporation. There is a chance that your company qualifies as an S corporation while others fall more in line with that of a C corporation.
Of course, significant differences in taxes can greatly affect you personally and your bottom line. The last thing anyone wants is to experience double taxation. Contact us now if you need help forming your company or filing your taxes. We also can help see if your business qualifies as an S corporation.