A corporation is a type of business structure that is created and regulated by state law. More specifically, it is defined as a legal entity that is separate from its owners (i.e., its shareholders). This means that only the corporation itself can be held liable for corporate obligations, such as maintaining certain business records.
There are many different types of corporations. Generally, a corporation is classified according to specific factors, including their tax structure, the purpose of the corporation, and the number of shareholders and amount of stock to be issued.
Some common forms of corporations are:
- C Corporation;
- S Corporation;
- Non-Profit Corporation;
- Business Corporation;
- Professional Corporation;
- Foreign Corporation; and
- Public or Private Corporation.
However, when someone mentions the term corporation they are usually referring to the two main categories that corporations are divided into according to tax laws: C Corporations and S Corporations. The main difference between these two types is that C Corporations are taxed separately from their owners, whereas S Corporations are not.
A few other benefits to forming a corporation are that: they can survive changes in ownership, meaning they can exist forever; they are considered “people” so they are entitled to certain constitutional protections; and since only the corporation itself can be held responsible for its obligations, they have limited liability.
Corporations are normally created by complying with state corporate laws. The majority of states base their laws on a model act called the “Revised Model Business Corporation Act (RMBCA).”
A corporation is formed when a document known as the “articles of incorporation” is filed with the Secretary of State. To form the articles of incorporation, the individual owners or shareholders will have to agree on a number of factors, which include:
- The name of the corporation;
- The number of shares the organization is authorized to issue;
- The number of shares of stock each owner will buy and the amount of money they will contribute to the purchase;
- The type of corporation; and
- The people who will form and manage the corporation.
As mentioned, each state has its own set of corporate law requirements. Thus, there may be additional factors to include when forming a corporation.
Corporate shareholders typically elect a group of individuals to serve as the corporation’s board of directors. The shareholders who hold the majority of shares will have ultimate control over the corporation since they have the strongest voting powers, which permits them to elect individuals to the board of directors.
The board of directors make the important corporate decisions and are required to meet at least once a year. The board then elects the officers of the corporation. The officers are the ones in charge of making the day-to-day decisions.
As mentioned above, a corporation is liable for its obligations. Thus, creditors may only rely on the corporation and its business assets to receive payments.
The individual shareholders are generally shielded from being personally liable for business losses, so long as the corporation was properly established and is run appropriately.
Therefore, the only risk the shareholders face are any investments they made in the corporation.
There are certain situations where limited liability will not protect an owner’s personal assets and for which they can be held personally liable. This may occur when an owner:
- Personally and directly causes injury to another person;
- Fails to deposit taxes withheld from wages of the corporation’s employees;
- Engages in activity that is intentionally fraudulent or illegal that causes harm to the company or someone else;
- Personally secures or guarantees a bank loan or a business debt on which the corporation defaults; or
- Treats the corporation as an extension of their personal affairs, rather than as a separate legal entity.
Additionally, there are some circumstances where a court can rule that a corporation does not exist and that its owners are actually doing business as individuals. In these types of cases, the individual owners may be held personally liable for any business obligations that arise.
This happens most frequently when there is a failure to follow corporate formalities, such as not:
- Adequately investing in (“capitalizing”) the corporation;
- Formally issuing stock to the initial shareholders;
- Regularly holding meetings of directors and shareholders; and
- Keeping business records and transactions separate from those of the owners.
One downside to forming a corporation is that they are subject to “double taxation.” Double taxation means that not only does the corporation have to file its own tax return and pay taxes on its profits, but the shareholders must also pay individual taxes on the dividends that they receive.
Additionally, the corporation must report all income it receives and can deduct any business expenses. Shareholders, on the other hand, cannot deduct any corporate losses.
While it is not necessary to have an attorney form your corporation, it is highly recommended that you do. Choosing the right entity, including even the right type of corporation, is a challenging task. The option you select will dictate the rest of your business decisions and how you make a profit.
Therefore, hiring an experienced corporate lawyer can be a benefit to helping you form a corporation. A lawyer can provide information about the different business structures, help predict what may work best for the purpose of your corporation, and can assist with preparing the right documents for filing.
If you are looking to change the type of corporation you initially chose, a lawyer can also help you with that as well.