What is a Corporation
A corporation is a legal entity that exists separately from its owners. Creation of a corporation occurs when properly completed articles of incorporation (called a charter or certificate of incorporation in some states) are filed with the proper state authority, and all fees are paid.
What are the advantages of incorporation
A primary advantage of incorporation is the limited liability the corporate entity affords its shareholders. Typically, shareholders are not liable for the debts and obligations of the corporation; thus, creditors will not come knocking at the door of a shareholder to pay debts of the corporation. In a partnership or sole proprietorship the owner's personal assets may be used to pay debts of the business.
Other advantages:
- A corporation's life is not dependent upon its members. A corporation possesses the feature of unlimited life. If an owner dies or wishes to sell their interest the corporation will continue to exist and do business.
- Retirement funds, qualified retirement plans (like 401k) may be set up more easily with a corporation.
- Ownership of a corporation is easily transferable.
- Capital can be raised more easily through the sale of stock.
- A corporation possesses centralized management.
What are the disadvantages to Incorporation
The primary disadvantage to a corporation is double taxation. Profits of a corporation are taxed twice when the profits are distributed to shareholders as dividends. They are taxed first as income to the corporation, then as income to the shareholder. All reasonable business expenses such as salaries are deductions against corporate income and can minimize the double tax. Further, the double tax can be eliminated by making an S corporation election.
Other disadvantages:
- Complexity and expense of forming a corporation.
- Extensive record keeping requirements.
- Operating a corporation across state lines requires the corporation to qualify to do business in the other state.
What is an S Corporation
Standard business corporations or C corporations are required to pay income tax on taxable income generated by the corporation. Making a Subchapter S election by completing and filing federal form 2553 with the IRS is a way to avoid having your corporation treated as a separately taxable entity.
An S corporation is a standard business corporation that has elected a special tax status with the IRS. This tax treatment allows the corporation not to be a separately taxable entity. Instead, the income of the corporation is treated like the income of a partnership or sole proprietorship; the income is "passed-through" to the shareholders. Thus, shareholder's individual tax returns report the income or loss generated by an S corporation.
To be classified as an S corporation, a corporation must make a timely filing of Form 2553 to the IRS. This election must be made by March 15 if the corporation is a Calendar year taxpayer in order for the election to take effect for the current tax year. A corporation may later decide to elect S corporation status, but this decision would not take effect until the following year.
In order to qualify for S corporation status, the shareholders must number fewer than 75. These shareholders must be individuals, estates or certain qualified trusts, who consent in writing to the S corporation election. The shareholders can not be non-resident aliens. Also, an S corporation can't issue preferred shares of stock with special liquidation, dividend or conversion rights.
What is the organizational structure of a corporation
The organizational structure of a corporation relies on three basic groups: shareholders, directors and officers.
A corporation is owned by shareholders; however, they do not directly manage the corporation. Instead, they influence corporate decisions through indirect methods such as electing and removing directors, approving or disapproving amendments to the articles of incorporation and voting on major corporate issues.
The board of directors are responsible for managing the affairs of the corporation. Usually, directors make only the major business decisions and supervise and appoint the officers who make the day-to-day business decisions of the corporation.
Officers are responsible for the everyday management of the corporation. Typically, officers are appointed directly by the board of directors.
It is important to note that a shareholder may serve on the board of directors and as an officer. In fact, in most states one person is enough to form a corporation.
How many directors do I need to form a corporation
Only one director is required in most states although you are allowed to have more. Some states use the number of shareholders in the corporation to determine the minimum number of directors. If the number of shareholders is three or more, then the corporation must have three directors. If the corporation has less than three shareholders, then the number of directors may equal the number of shareholders. States which have this rule:
AR, CA, HI, LA, ME, MD, MA, MO, NY, OH, UT, VT.