A corporation is a legal business form that is separate from its owners (a separate legal entity from shareholders). The shareholders, board of directors, and officers are the basic corporate structures. The shareholders are investors and the people who own the company. It means they purchased the stock and legally possess the assets of the business. Due to thousands or millions of shareholders, they cannot run the business daily.
Corporations are the most common form of business in the U.S. due to their ease of formation and limited liability protection. Corporations are established when owners (shareholders) file articles of incorporation with a state. Each state has varied rules on how these companies must operate in their state and what fees they have to pay. There are four different types of corporations to be aware of: a Limited Liability Company (LLC), an S-Corporation (S-Corp), and a C-Corporation (C-Corp).
What is a Corporation?
A corporation is a legal entity whose investors purchase shares of stock. They do this to serve as proof of their ownership interest in it. The entity acts as a legal shield for its owners, meaning they are typically not liable for the corporation’s actions. However, they can benefit from dividend payments and appreciation in the value of their shares. Corporations have most rights and obligations as individuals (being able to enter into contracts, hire new employees, own assets, incur obligations, and pay taxes). A board of directors that shareholders elect represents their interests.
How do Corporations Work?
Individuals or groups of people can create a corporation with a shared goal. This does not always consist of making a profit. But, most corporations aim to return a profit to their shareholders. Certain corporations, such as charities or fraternal organizations, are nonprofit or not-for-profit. No matter the situation, their shareholders (owners of the corporation) do not accept responsibility for it past the potential loss of their investment. A corporation’s most significant characteristic is limited liability. That means shareholders can partake in profits through dividends and stock appreciation. But, they are not personally liable for the company’s debts.
How is a Corporation Formed?
A corporation is formed through a legal process known as incorporation. During the procedure, legal documents containing the primary reason for the business, name, location, and the number of shares and stock issued, are drafted. Incorporation gives business entities unique features that protect the owners from being personally liable in case of a lawsuit or legal claim. Each state has various laws regarding incorporation, but most want owners to file articles of incorporation with the state. Then, the stock is issued to the company’s shareholders. Shareholders will then elect the board of directors in an annual meeting.
Who Owns a Corporation?
Shareholders own corporations. They gain interest in a business when they purchase shares of stock. The shareholders then elect a board of directors who are responsible for managing the corporation. Shareholders share ownership of corporations which is represented by their stock of shares. They are united in that they all aim to pursue a common goal. However, shareholders do not accept responsibility beyond the potential loss of investment in it. Private or “closed” corporations might have a single shareholder or several members. Publicly-traded corporations have thousands of shareholders.
How many Incorporators should a Corporation have?
The number of incorporators per corporation varies. For some states, at least 3 incorporators are required for a single corporation. However, having 1 or more incorporators is common for many corporations. Incorporators are in charge of creating corporations and registering them with states. Also, they are responsible for filing the paperwork and signing the articles of incorporation. Businesses are not fully incorporated or legally registered without incorporators. But remember, incorporators are not always the same people who will own it. Sometimes they are strictly available solely to incorporate the business.
What are the Characteristics of a Corporation?
When you start a business, you have to decide on how to organize the business. Some business owners are sole proprietors under a DBA (“doing business as”) moniker. In contrast, most owners choose an entity with personal liability protection and more diverse investor options or transfers of ownership. Corporations are one of the most common entities.
The following are five of the main characteristics of a corporation.
1. Limited Liability:
Corporations grant owners limited liability against debts and lawsuits filed against the company. Therefore, any loans, credit cards, mortgages, or revolving credit with vendors are the sole responsibility of the company. The same applies to lawsuits or insurance claims against the company.
Limited liability is best depicted when a company endures financial hardship and files for bankruptcy. Payroll, taxes, and debts are paid before any shareholder receives payment from the remaining assets. But, shareholders do not have to pay anything if these assets are not enough to pay everything off.
2. Double Taxation:
For smaller corporations, double taxation is a serious consideration. The corporation is taxed on earnings at the business level. Profits that are distributed to shareholders are also taxed as dividends. The overall revenues and how much is distributed to shareholders have a substantial financial impact on the owners. Remember, there are two types of corporate structures (the C corporation and the S-corp). Smaller businesses may choose S-corp to pass revenues directly to owners so they can mitigate double taxation.
A corporation is its own entity, which means it has a lifespan that only ends when the board of directors and owners vote to dissolve the business. A corporation goes far beyond the lifespan of human owners. People can transfer stock shares upon death or have the ability to be sold and transferred from person to person. Transfers occur through a public stock exchange or private transactions for nonpublic entities.
4. Professional Management:
Owners of corporations can vote on decisions for the board of directors to make final directives. Still, shareholders are not always the managers of a company. For numerous small businesses, the majority shareholder is the founder and main leader of the company. But, any corporation can hire a company leader while reaping the benefits of the profits. The board of directors votes on major budget items.
5. Shareholders’ Involvement:
Shareholders own corporations. A fixed number of stock shares are supplied when the corporation is formed. One person or many shareholders can own stock shares. Public corporations selling stock on stock exchanges may have millions of owners for any given company. Shareholders can vote based on the number of shares they own. And the more shares an owner has, the more control they have over business decisions.
The five main characteristics listed offer ways to identify a corporation. There are other factors applicable to corporations, but these main five are always relevant. These characteristics are part of forming the organization and ensuring that things run smoothly.
What are the Different Types of Corporations?
Corporations appear in many forms, and each has unique responsibilities and structures. However, they all differ in how they treat taxes and income. For employees, the type of organization they work for generally has little effect on their work. But that factor primarily affects shareholders and executives.
Below are the different types of corporations.
|C Corporations||The federal government taxes C corporations separately from their owners. Many major companies act as C corporations for U.S. federal income tax purposes. They are also eligible for an unlimited amount of shareholders (foreign and domestic). Companies treat the distribution from earnings and profits as dividends for U.S. income taxes. Distributions in the liquidation of the corporation and the termination of shareholders’ interests are the only exceptions to this situation.|
|S Corporations||S corporations pass corporate financials like income, losses, credit, and deductions to shareholders for tax purposes. Like C corporations, this corporation type follows the state laws in which it resides. The considerable difference is that S corporations treat themselves as partnerships for tax purposes. So, they tax income at the shareholder level instead of the corporate level and issue tax-free payments to shareholders. Specific corporate penalties such as personal holding tax or accumulated earnings tax do not apply to S corporations. To become an S corporation, you have to meet eligibility requirements, have a single class of stock, and have 100 or fewer shareholders.|
|Limited Liability Companies||Limited Liability Companies (LLCs) have a partnership and corporate structure elements. This type of corporation provides limited liability to owners. LLCs have pass-through income availability in taxation and are usually more flexible than corporations, which means they are more suitable for companies operating under a single owner.|
|Nonprofits||Nonprofit organizations use surplus revenues to achieve goals for various causes, and they use this rather than distribute them as profits or dividends. For self-preservation, expansions, or other long-term goals and plans, nonprofits must sustain themselves independently. Most, if not all, of the income that nonprofits earn, is through private donations.|
What are the Advantages of Forming a Corporation?
Corporations are legal entities organized under state laws. The investors purchase shares of stock as proof of ownership in it. There are various benefits to forming a corporation.
Listed below are the advantages of forming a corporation.
- Limited Liability. Shareholders of corporations are only liable up to the number of their investments. The corporate entity protects them from any further liability, so their personal assets are protected.
- Source of Capital. Publicly-held corporations can raise substantial amounts when they sell shares or issue bonds. This particular advantage applies when its shares trade on a stock exchange, where it is easier to buy and sell shares.
- Ownership transfers. It is more difficult for privately-held entities to sell shares in a corporation due to different rules. But usually, it is not difficult for shareholders to sell shares.
- Perpetual Life. Corporations have no expiration date since ownership of it can pass through many generations of investors.
- Pass-Through. If a corporation is structured as an S-corporation, profits and losses are passed onto shareholders. This means the corporation will not have to pay income taxes.
The advantages listed above show the positive aspects of forming a corporation. Many people decide to start a corporation based on these reasons. However, there are some disadvantages. Depending on the corporation, it may pay taxes on income. Then shareholders pay taxes on any dividends received so that income can be taxed twice. Also, various types of income and other taxes that must be paid can require substantial paperwork. The S-corporation is the only exception to this situation. And suppose several investors have no apparent interest. In that case, the management of a corporation can operate the business without any supervision from the owners.
What are the Disadvantages of Forming a Corporation?
Corporations do not suit everyone, and they can wind up costing you more time and money than they should. Before forming a corporation, be aware of the following potential disadvantages.
Listed below are the disadvantages of forming a corporation.
- Lengthy Application Process:
Filing articles of incorporation with the secretary of state can be quick, but the overall process of incorporating is long. You will have to endure extensive paperwork to properly study and document the details of the organization and its ownership. For instance, if someone said that you must draft and maintain corporate bylaws, appoint a board of directors, and issue stock certificates, then all of this has to be noted.
- Strict Formalities, Protocols, and Structure:
Besides the lengthy application process, you must factor in the time and energy that goes into maintaining a corporation and adhering to legal requirements. You must abide by many formalities and heavy regulations to maintain your corporation status. For example, you have to follow your bylaws, hold annual meetings, keep board minutes, and create annual reports as part of the guidelines. Restrictions are also placed on certain corporations, such as S-corps (which can only have up to 100 shareholders who all must be U.S. citizens).
- Double Taxation:
Most corporations like C-corps face double taxation. Double taxation means the business income is taxed at the entity and shareholder level (based on the percentage of profits earned). The only exception to this is to function as an S corporation. S-corps avoid this problem by only taxing each shareholder on their individual income, not at the entity level. But, the IRS can tax them as C-corps if their records do not meet the legal requirements.
Corporations are expensive to form and operate. It is easier for established corporations to raise capital by selling shares, but forming and maintaining corporations can be costly. You may need a lot of startup capital to get a corporation running, and you also have to consider paying the filing charges, ongoing fees, and larger taxes. When you weigh the pros and cons of whether a corporation is suitable for your business, consult an attorney and an accountant who are knowledgeable in creating a corporation.
What Happens When a Corporation Dissolves?
You create a corporation by filing documents with your state, and you have to go through a similar process to dissolve it. Otherwise, a corporation can continue to exist even though you no longer use it for business. So, your state filing and other legal obligations remain, and the corporation stays open to lawsuits and can incur additional liability. It is crucial to follow through with necessary filings when deciding to close the corporation. Each state has specific rules, so seek help from a business lawyer to ensure you follow your state’s requirements. Some steps to follow are a board meeting to vote on the dissolution, sending a notice to claimants, and obtaining tax clearance.
Is a Corporation the same as a Company?
Yes, but not all companies are corporations. Companies refer to individuals and business partners joining together to conduct commercial activity. Companies vary from a sole proprietorship, partnership, or corporation. Companies or other enterprises may want to incorporate. But for corporations, the enterprises exist as legal entities separate from their owners. Owners cannot be held responsible for the debts of the corporation. Corporations can also own assets, sue or be sued, and borrow money.