What is a Corporation?

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Quick Reference

A corporation is a legal business entity created through the process of incorporation for the purpose of operating a for-profit business. A corporation is considered separate from its owners. The owners of a corporation are referred to as “shareholders.”

In other entities, such as the sole proprietorship or general partnership, the business owners are personally liable for the debts and obligations of the company. This means that if the business assets are not sufficient to satisfy the debt, creditors can go after the shareholder’s personal assets more easily.

Both the corporation and Limited Liability Company (LLC) provide their owner’s personal liability protection. Learn more about the differences between a corporation and an LLC.

Shareholders in a corporation or members of an LLC are not personally liable for the obligations and most debts of the business. Business debts are not required to be paid by the owners unless they sign a personal guarantee to get a loan from the bank. This distinction is the primary reason many entrepreneurs are interested in establishing a corporation or LLC.

Types of Corporations

All corporations begin as C Corporations. However, there are really two corporate tax designations to select.

C Corporation

A Subchapter C Corporation or “C Corp” is the most common type of corporation. The owners receive profits from the corporation. These profits are taxed individually while the corporation is taxed on the same earnings as a separate entity. C Corps provide more flexibility in stock options than S Corps due to the limitations on S Corp eligibility.

S Corporation

An S Corporation election or “S Corp” is a special tax treatment by the IRS. The critical difference between these two types is that S Corps enjoy pass-through taxation. This means that the owners pay taxes on the business profits through their personal tax returns, avoiding the dreaded “double taxation” associated with C Corps. However, there are a few limitations on companies seeking S Corp status. Corporations seeking this election may not have more than 100 shareholders, more than one class of stock, and the company cannot be owned by a C Corp, S Corp, partnership, or trust. Also, all shareholders of an S Corp must be U.S. citizens or lawful residents.

The default tax election for a corporation is the C Corporation. To elect S Corporation status, IRS form 2553 will need to be filed.

Advantages of Forming a Corporation

The biggest advantage of operating as a corporation is the total separation of the owners and business. This means that the corporation can conduct business, buy property, execute contracts, conduct financial transactions, and pay taxes separate from the identity of the owners.

Corporations also have limited liability protection, much like LLCs. The owners of corporations are only liable to creditors and lenders for the amount they individually invested or personally guaranteed. This protection is important as it protects the owner’s personal assets should the business be sued.

Unlike other types of business entities (such as general partnerships), a corporation does not dissolve or expire upon the death or departure of its officers or shareholders. Corporations exist in perpetuity until formally dissolved.

Publicly held corporations have the benefit of easy transfer of ownership of company shares. For this reason, the corporate structure is often sought by companies in need of capital raising.

Disadvantages of Forming a Corporation

Since a corporation is a more complex entity structure, the incorporation fees are usually more expensive than those for forming most other types of entities, like partnerships or LLCs.

Owning and operating a corporation requires diligent compliance with more formalities than most other types of entities. For instance, a board of directors must be elected to manage the corporation overall. The board is then tasked with hiring officers to oversee the day-to-day business operations. Also, there are annual meeting requirements for both shareholders and directors. To some business owners, these formalities seem unnecessary and burdensome; however, they are critical in keeping attorneys from “piercing the corporate veil. “

The most significant disadvantage of forming a corporation is what is known as “double taxation.” The entity pays the corporate income tax rate on its profits, and the owners pay taxes on any wages earned from the corporation.

Can a Corporation Have One Owner?

Yes, corporations may have one owner. One person may serve as the single shareholder, director, and officer for the corporation. Although corporate formalities must be adhered to no matter the number of owners, it is especially important to document your activities as a single-owner corporation. This means you will need to hold meetings and draft corporate minutes of those meetings, even if you are the only one in attendance.

The maximum number of owners permitted depends on which type of corporation you choose. C Corps may have an unlimited amount of owners. However, S Corps can only have as many as 100 owners.

How to Form a Corporation

A corporation is formed by filing Articles of Incorporation in the state (typically with the Secretary of State) in which the business intends to operate. The Articles of Incorporation are similar to the Articles of Organization, which are for LLCs. The information covered in this document should include the following:

  • The name and physical address of the corporation
  • A description of the corporation’s primary purpose and business activities
  • The names of the board of directors, their titles and responsibilities
  • Number of shares authorized, the class of shares, and the value of each share
  • Information of the corporation’s registered agent

Other documents that will need to be drafted include corporate bylaws and shareholder agreements. Corporate bylaws provide written guidance regarding the operation of the company and can be amended as required. Usually, the rules described in the bylaws include the following provisions:

  • Date and setting for the annual meetings
  • The number of directors and the length of terms
  • Procedures for adopting and amending bylaws
  • Procedures for shareholder approval of corporate transactions and agreements
  • Buy-sell or buyout rules in the event of a shareholder’s death, disability, retirement, etc.

New corporations are also required to obtain an Employer Identification Number (EIN). This is a uniquely assigned number that the IRS uses to identify a business for tax purposes.

Once the corporation is formed, stock certificates will need to be drafted and issued to the stockholders.

If you want to form an S Corp, you will need to go through the incorporation process described above and then file a Form 2553 with the Internal Revenue Service to elect S Corp status.

Corporation vs. Limited Liability Company

An alternative to forming a corporation is forming an LLC.  An LLC, like the corporation, creates a separate legal entity, which protects the owner’s personal assets. Owners of an LLC have very similar liability protection and greater tax flexibility than the corporation, without having as many administrative burdens.

Related: LLC vs. Corporation, What’s Right for You

Relevant Links:

IRS-Election by a Small Business Corporationhttps://www.irs.gov/forms-pubs/about-form-2553https://startingyourbusiness.com/what-is-a-registered-agent-and-when-do-i-need-onehttps://startingyourbusiness.com/what-is-a-registered-agent-and-when-do-i-need-oneregistered agent

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