Corporations are a common business form, and their popularity is due to the benefits that the business owners receive through incorporating as opposed to choosing another business form, such as a partnership, for example. The corporate form can help protect your personal assets, and some corporations can provide tax benefits.
In order for you to decide if the corporate form is the best alternative for your new small business, there are a lot of basic things to know and understand about corporations, like the different types of corporations, how they're formed, how they work and who's involved with running the business.
Forming a corporation can be a complex matter, and it's governed almost entirely by the laws of the state where you choose to incorporate. So, be certain to thoroughly research the laws of the state where you intend to incorporate, or consider getting some help from an experienced business law attorney.
Two Types of Corporations
For tax purposes, and particularly for federal tax purposes, there are two types of corporations:
A C-corporation is subject to a two-tier federal tax scheme, that is, there's "double taxation." The first tax is on the corporation: it must pay taxes on its profits, and it can deduct its losses. The second tax happens when the shareholders or owners get money from the corporation: they have to pay taxes on money they receive, such as salaries or stock dividends; they can't take deductions for the corporation's losses.
An S-corp is taxed much differently because it has elected a special federal tax status. For tax purposes, an S-corp is treated like a partnership or sole proprietorship: profits made by the corporation (and losses suffered by it) "pass through" the corporation directly to the owners or shareholders. The owners then report the profits and losses on their individual tax returns.
Forming & Managing a Corporation
All corporations are formed the same way, and the process is established by the laws of the state in which you incorporate. Laws vary by state, but generally you have to:
- Write articles of incorporation, which contain the corporation's name, address, and name of its "registered agent"- the person who will accept important documents on behalf of the corporation, such as legal and tax documents.
- Write corporate bylaws, which set out how the corporation will be run, that is, when meetings will be held by the board of directors or for the shareholders, voting procedures for business decisions made by the corporation, and the number of officers and directors.
- Choose the corporation's board of directors.
- Issue stock certificates, which represent an ownership interest in the corporation. S-corps can issue only one "class" of stock, while C-corps can issue several classes. Classes of stock usually pertain to voting rights: Class A stock typically carries 1 vote per share, while Class B stock can carry multiple votes per share, say 5 votes per share. Class B stock is usually issued to founding members of the corporation, while Class A stock is typically offered to the public for purchase, such as on a stock exchange.
The primary benefit of choosing the corporate form for your small business is limited liability for the corporation's debts. Generally, a corporation's officers, directors and shareholders can't be held personally liable for the corporation's debts. So, if the corporation fails to repay a bank loan, the bank can't sue you and take your house or car for repayment of the loan. There are exceptions, though. For example, you'll be personally liable on a loan if you personally guaranteed repayment of it.
In addition, there are two tax benefits, namely, deductions for premiums paid on:
The Key Players
Corporations are made up of three groups:
- Shareholders, or stockholders
Directors make the business decisions for the corporation. At first, they are usually named in the articles of incorporation. After that, the shareholders elect them. The number of directors depends on the size of the corporation: a large corporation could have several directors, while your small business could have only one.
Officers actually run the day-to-day operations of the corporation; they are responsible for putting the directors' decisions into action. They are usually appointed by the board of directors. Again, the number of officers depends on the corporation's size, and you could serve as the only officer (and the only director) of your small business. However, corporations typically have a:
- President, or chief executive officer (CEO), who is the person responsible for daily operations
- Treasurer, or chief financial officer (CFO), who manages the corporation's money and keeps financial records
- Secretary, who keeps the corporation's non-financial documents and records, such as the minutes of shareholders and directors meetings
Shareholders actually own the corporation. They invest money in the corporation and in exchange receive stock certificates or "shares," which represent how much ownership interest each shareholder has. That interest can range anywhere from a fraction of 1 percent to 100 percent. If the corporation has more than one shareholder, then each shareholder must have at least one share of stock.
Shareholders have almost nothing to do with the management or day-to-day operations of the corporation.
Questions for Your Attorney
- How much will it cost and how long will it take to form a corporation?
- What's the difference between a corporation and a limited liability company (LLC)?
- Can I stop my shareholders from selling their shares?