A corporation is a legal entity independent of its members. It holds authority and can incur liability on its own.3 min read
What is an example of a corporation? Apple Inc., Walmart Inc., and Microsoft Corporation are all examples of corporations.
Basics of a Corporation
A corporation is a legal entity independent of its members. It holds authority and can incur liability on its own. A corporation conducts its business like an artificial person.
Traditional corporations are often known as C corporations. The letter "C" refers to Section C of the Internal Revenue Code (IRS) under which corporations file their corporate taxes. By default, the IRS treats a corporation as a C-corp unless it is registered as some other type of corporation.
Characteristics of a Corporation
Following are the major distinguishing characteristics of a corporation:
Ownership
Shareholders are the owners of a corporation.
Board of Directors
A corporation is managed by a board of directors, which is elected by the shareholders.
Perpetual Existence
A corporation continues to exist for an unlimited period of time. It remains unaffected by the retirement or death of its shareholders. A corporation terminates only if:
- Its shareholders dissolve it, or
- It becomes bankrupt.
Limited Liability
Shareholders of a corporation have limited liability. If the corporation becomes bankrupt, creditors cannot pursue personal assets of the shareholders. However, under certain circ*mstances like fraud and illegal activities, courts may lift the corporate veil and make the shareholders personally liable for the resulting debts and liabilities.
The limited liability feature has made corporations a popular form of business in the United States. If the corporation is unable to meet its debts and obligations, its shares tend to lose their value. However, shareholders cannot be forced to pay back the company debts.
Corporate Taxes
Corporations are liable to pay taxes on their income even if the income is distributed among shareholders as dividend. Since the distributed income is again taxed in the hands of the shareholders, this often results in double taxation.
Distinct Legal Entity
Corporations are distinct legal entities that exist independent of their shareholders. They can own assets, enter into contracts, borrow money, sue others, and can be sued in their own name.
Disadvantages of a Corporation
The corporate structure may not be suitable for all types of businesses. Forming and operating a corporation involves lots of formalities and paperwork. They are highly governed entities compared to other forms of businesses like partnerships and sole proprietorships. Corporations are also more expensive to operate.
Double taxation is a common complaint against corporations. Shareholders end up paying taxes twice on their business income: first in the hands of the corporation and then again in their individual capacity when they receive their business income as dividend.
What Is an S Corporation?
An eligible corporation can elect for special tax treatment under subchapter S of the IRS code. Making an S-corp election allows the corporation to pass through its profits and losses to its individual shareholders instead of paying income tax at the corporate level. Thus, an S-Corp election is effective in eliminating double taxation.
Advantages of an S corporation
- Limited liability.
- Pass-through taxation.
- Attractive for investors.
- Tax filing frequency of just once a year.
Disadvantages of an S corporation:
- Ownership or membership is restricted to citizens and legal resident of the United States.
- You cannot have more than 100 shareholders.
- You must first go through the complete process and cost of incorporation before being able to make the S-corp election.
- Failure to file mandatory returns and taxes may result in termination of your S-corp status.
- S corporations are subject to closer IRS scrutiny.
How to Form a Corporation
- Determine the state for incorporation.
- Choose a business name.
- Appoint the initial directors.
- File the articles of incorporation with the concerned state agency (usually the secretary of state) and pay the applicable filing fee. Articles act as the corporate charter; they create a corporation.
- Draft the corporate bylaws for internal governance of the corporation.
- Conduct the first board meeting of directors.
- Obtain necessary licenses and permits applicable to your industry and place of business.
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Now, let's delve into the concepts mentioned in the provided article:
1. Basics of a Corporation:
- Legal Entity: A corporation is a legal entity distinct from its members, granting it independent authority and liability.
- Artificial Person: Conducting business like an artificial person implies that a corporation can enter contracts, own assets, sue, and be sued.
2. Characteristics of a Corporation:
- Ownership: Shareholders own the corporation.
- Board of Directors: Management is overseen by a board elected by shareholders.
- Perpetual Existence: Corporations can exist indefinitely, unaffected by shareholder changes unless dissolved or bankrupt.
- Limited Liability: Shareholders have limited liability, protecting personal assets, but exceptions exist for fraud and illegal activities.
- Corporate Taxes: Corporations pay taxes on income, leading to potential double taxation.
3. Distinct Legal Entity:
- Independent Existence: Corporations exist independently, capable of owning assets, entering contracts, and engaging in legal actions.
4. Disadvantages of a Corporation:
- Formalities and Paperwork: Operating a corporation involves significant formalities and paperwork.
- Expense: Corporations are costlier to operate than other business forms.
- Double Taxation: Shareholders may face double taxation on business income.
5. What Is an S Corporation:
- Special Tax Treatment: An eligible corporation can choose S-corp status for pass-through taxation, avoiding double taxation.
- Advantages: Limited liability, pass-through taxation, attractiveness for investors, and reduced tax filing frequency.
- Disadvantages: Restrictions on ownership, a limit on the number of shareholders, incorporation process, and IRS scrutiny.
6. How to Form a Corporation:
- State of Incorporation: Choose the state for incorporation.
- Business Name: Select a business name.
- Initial Directors: Appoint initial directors.
- Articles of Incorporation: File with the state agency and pay the filing fee.
- Bylaws: Draft internal governance bylaws.
- Licenses and Permits: Obtain necessary licenses and permits.
- Board Meeting: Conduct the first board meeting.
This overview provides a comprehensive understanding of the key concepts related to corporations, their characteristics, advantages, disadvantages, and the process of forming an S Corporation. If you have further questions or need assistance in legal matters related to corporations, feel free to seek advice from qualified legal professionals.
