Learn more about closely held corporations, how they work, and their pros and cons.
What Is a Closely Held Corporation?
Closely held corporations are businesses where a few individuals own the majority of shares.
Alternate name: Close corporation
The vast majority of small corporations in the U.S. are closely-held. To qualify as a closely held corporation, a business must fit the following requirements:
Have more than 50% of the value of its outstanding stock owned, directly or indirectly, by five or fewer individuals at any time during the last half of the tax yearNot be a personal service corporation
How Closely Held Corporations Work
A closely held corporation, by definition, is a private corporation because its shares are not traded publicly on a stock exchange. The shareholders may be family members, business partners, or any small number of investors. A closely held corporation is a private corporation, but a private corporation may or may not be closely held; the critical distinction is the number of shareholders. The following characteristics describe the features of a closely held corporation:
Few shareholdersLimited number of shares (set by individual states)Informal operating structureShareholders operate the businessDecisions are made based on the shareholder agreement
Closely Held Corporation Taxes
A closely held corporation may be a C corporation or S corporation, which is an important classification for tax reasons. If you form a closely held corporation, and it meets the IRS criteria for S corporation status, all profits are passed through to the owners’ personal tax returns. If it’s classified as a C corporation, it will be subject to regular corporate taxes, and owners will also be responsible for paying personal taxes on the income received from the corporation. Closely held corporations that are not S corporations can apply the passive activity rules, which limits owners’ loss from passive activities to their passive activity income. If a shareholder doesn’t serve on the board or work in management, that would be considered passive. There are also at-risk rules that limit owners’ losses from activities to their amount at risk in the activity. The risk can be equal to the amount of money contributed to the activity or any amount borrowed for it.
Pros and Cons of Closely Held Corporations
Pros Explained
Less regulations: Closely held corporations don’t have to abide by as many corporate regulations as publicly traded companies, which are regulated by the Securities and Exchange Commission. This allows them to forgo many formalities like filing financial statements.More control: Since there are few shareholders, owners have more control over the company. They can make business decisions without consulting with a board of directors or relying on public shareholder votes. This allows them to run the company how they want.
Cons Explained
Process of selling shares: Unlike publicly traded companies, closely held corporations can’t list their shares on a public stock exchange; if one of the shareholders wants to sell some or all of their shares, the pool of potential buyers is minimal. Even once a potential buyer and seller connect, there is a chance that they disagree on the company’s value.Harder to raise money: Not being able to sell shares on a public stock exchange limits the way closely held corporations can raise money. The business generally relies on capital contributions from its owners.Taxes: State laws vary regarding closely held corporation classifications. If the business is in a state that treats closely held corporations as C corporations, owners could face double taxation. The company pays taxes on profits, and the shareholders pay personal income taxes.
