What is a Corporation?
A corporation is a business organization which is chartered by a state (known as the state of incorporation) in accordance with the state’s incorporation statute. In the eyes of the law, a corporation is a separate person – just like you and I are separate people. A corporation can own both personal property and real property, sue, be sued, commit crimes, be victimized by crimes, make decisions, hire and fire employees and give gifts. Unlike general partnerships and sole proprietorships, a corporation is a “going concern”. The lifetime of a corporation can be perpetual and completely separate from that of its owners (who are known as shareholders).
How to Create a Corporation
A corporation is created by filing “articles of incorporation” in compliance with a state’s Corporations Act. Although the exact requirements vary from state to state, most state acts are based on the Model Business Corporation Act, which establishes a four step process for creating a corporation. These four requirements are:
- Filing of Articles of Incorporation: Articles of Incorporation containing all of the “mandatory provisions” must be filed with the secretary of state.
- Payment of a Filing Fee.
- An Incorporator: An entity (such as an existing corporation or existing partnership) or adult human being must sign the articles of incorporation.
- Organizational Meeting: After articles of incorporation are filed, an organizational meeting of the shareholders and directors must be held to adopt bylaws (the rules governing the internal management of the corporation), elect officers, and transact business.
Article of Incorporation Mandatory Provisions
Most state Corporation Acts contain five mandatory provisions which must be included in the articles of incorporation. These provisions are:
- Name: The name of the corporation must include either the word “incorporated”, “company”, “corporation”, “limited”, or an abbreviation of one of these words, making it clear to the public the entity is a corporation. The corporate name cannot be deceptively similar to any existing corporate name registered with the secretary of state and must be distinguishable from any existing corporate name registered with the secretary of state.
- Number of Authorized Shares. The number of shares the corporation is authorized to issue must be included. The corporation cannot issue shares in excess of this amount without following the procedures required to amend articles of incorporation.
- The name and address of each incorporator.
- Purpose: Although many states and the Revised Model Business Corporation Act have eliminated the requirement, some states require a statement of the corporation’s specific purpose. For example, the purpose of the corporation is to conduct a landscaping business. The majority of states allow the articles of incorporation to have “conduct any lawful business” as its purpose clause.
Registered Agent and Office: The articles of incorporation designate both a registered agent and a registered office for the corporation. As a general rule, the registered office must be a place within the state of incorporation at which the registered agent can receive mail and cannot be a post office box. The registered agent can be an adult human being or an entity authorized to serve as a registered agent in the state of incorporation.
Consequences of Incorporating
Tax Consequences
While corporations are created by state law, they are taxed by both the federal government and the governments of the states in which they conduct business. Under the Internal Revenue Code of the federal government, a corporation may be either a “C” corporation or an “S” corporation. A “C” corporation is taxed on its taxable profits. Thereafter, a “C” corporation distributes its after tax profits to its shareholders by paying its shareholders dividends. The shareholders pay income taxes on the dividends. This process is commonly referred to as “double taxation of corporations.” A “C” corporation must annually report its taxable income by filing IRS Form 1120.
With some exceptions, a “S” corporation passes its profits and losses onto its shareholders. A “S” corporation is sometimes referred to as a “pass through entity” because it does not, with some exceptions, pay income taxes itself. A “S” corporation must annually report its profits and losses by filing IRS Form 1120S. Liability Consequences
The primary benefit of conducting business as a corporation is limited liability. As long as appropriate formalities are observed and the corporation is not intentionally undercapitalized, the shareholders of a corporation are not personally liable for the debts and other obligations of the corporation. Only the corporation itself can be held liable for the debts and other obligations of the corporation. This serves to limit a shareholder’s potential loss to the amount the shareholder paid for his or her shares.
Advantages of Operating as a Corporation
The major advantages of a corporation are:
- Limited liability for shareholders
- Centralized Management: The shareholders of the corporation elect a board of directors to establish policy and strategy for the business of the corporation. The board of directors also appoints officers of the corporation to run the day to day operations of the business. The corporate structure allows many people to own the business without hindering the day to day operations of the business.
- Transferability of Ownership: As a general rule, shareholders can sell shares in the corporation to any party at any time for any price. This is not the case with the ownership of a partnership. In a partnership structure, the sale of a partnership interest causes an automatic dissolution of the partnership.
- Flexible Equity Structure: By simply issuing more shares, a corporation can generate capital for itself and bring in more owners and investors with more ease than other forms of doing business.
- Indefinite Lifetime: A corporation can exist in perpetuity. Changes in ownership do not affect the existence of a corporation. Ownership of a corporation can also be more easily passed between generations.
Disadvantages of Operating as a Corporation
The disadvantages of a partnership are:
- Double taxation of a “C” corporation.
- Formalities: In order to receive the liability limiting benefits of being a corporation, corporate formalities must be followed. These formalities can be cumbersome for owners of closely held corporations. For this reason, most states have adopted statutes creating “closely-held corporations” which are subject to fewer formalities.
- Cost: A filing fee payable to the secretary of state to create the corporation. Most states require payment of an annual “franchise tax.”
With the advent of the internet, access to forms of all varieties is easy – maybe too easy. Selecting the appropriate form of doing business and appropriate taxation structure for you and your business is complex. You want your business to be a success. Be careful. Engage a knowledgeable accountant and attorney to serve you – and step off on the right foot.
Legal Disclaimer
This website provides information addressing legal topics of interest to the general reader. You should not consider this information designed or adequate to meet any of your particular legal needs, concerns or inquiries. You should consult with a lawyer licensed to practice law in the jurisdiction appropriate to your legal situation to assess your situation and provide you with appropriate legal advice.