Introduction to Close Corporations

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Introduction to Close Corporations

Filed under: Corporations

By: Richard A. Chapo

Mention the corporate entity and most people start thinking about S or C designations. In some states, close corporations are another variable that are available.

First things first - a close corporation does not refer to a closing as with a door. It refers to a limited number of shareholders. It is a unique entity that is not available in all states, but is worth a look where it is.

The close corporation was originally designed to be a more user-friendly business entity than traditional corporations. It was the LLC before limited liability companies existed. Once LLCs received favorable tax designations in the late 1980s, the close corporation became the forgotten stepsister of business entities. That being said, it offers some unique advantages.

So, what advantages does the entity have over the LLC? The biggest advantage often has to do with state taxes. Many states have taken note of the popularity of the LLC and passed fees and taxes that make the LLC unattractive. In California, for instance, there is a gross revenue tax on the LLC. Yes, GROSS revenues. The close corporation faces no such tax.

Another advantage of a close corporation compared to an LLC is the protection from personal liability it provides. The protection is exactly the same as found in traditional corporations. LLCs are purported to offer such protection, but the truth is nobody is absolutely sure this is the case. The protection provided by the corporate entity has been hashed out over hundreds of years and is clear. The LLC is only 20 years old as a commonly used entity and the courts have not yet fully ruled on how the liability shield will work.

There are limits and downsides to the close corporation. First, the number of shareholders is restricted, often to 25 to 35 shareholders. Also, minority shareholders have a lot of power. A single shareholder, for instance, may be able to file a request for involuntary dissolution of the corporation with the relevant Secretary of State. This can, of course, lead to some interesting board meetings. Finally, close corporations run the real risk of being attacked through alter ego claims as they are often run shoddily by the limited number of shareholders and directors.

The close corporation is a business entity that provides an interesting and unique set of positives in states where it is available. The regulations applicable to it vary by state and you should investigate those in your jurisdiction before addressing them.

Richard A. Chapo provides California incorporation services through SanDiegoBusinessLawFirm.com.