Ever wonder what do Apple, Walmart Inc., Ford Motor Co. and Amazon have in common other than being extremely popular among customers? All of them are corporations. This legal structure has many advantages over sole proprietorships and partnerships, such as a perpetual existence and limited liability for their investors. The laws governing corporation vary among states and countries. In the U.S., the legislation is based on the Model Business Corporations Act, which has been in effect since 1950 and revised over the years.
What Is a Corporation?
Before starting your own business, it's necessary to choose a legal structure. Sole proprietorships, limited liability companies or LLCs, partnerships and corporations are your main options. Each has its advantages and drawbacks and falls under different laws.
A corporation is a legal entity of its own and enjoys most of the rights that an individual has. It can hire people, sue companies and individuals, purchase assets and apply for loans. This type of company is separate from its owners.
Other characteristics of a corporation include the ease of capital acquisition, limited liability for stockholders, transferability of ownership and centralized management. Furthermore, it has an unlimited life until it's formally dissolved. This means that if one or more of its founders die or retire, the company will continue to exist.
This type of business is created when a group of people called shareholders or stockholders join forces to pursue a common goal. The company may be privately or publicly held and its stocks can be traded on a stock exchange. Its ownership is divided into shares of stock. Stockholders' liability is limited to the amount of money they invested.
If you decide to have a company registered as a corporation, take the time to understand its key aspects. The corporate structure chart, double taxation, shareholders' rights and responsibilities, management requirements and the transferability of shares are just a few to mention. Discuss the structure and features of the corporation with potential partners to decide whether this type of business aligns with your goals. Be aware that corporations have their drawbacks.
Types of Corporations
There are several types of corporations and each has distinctive traits. These include:
- C corporations.
- S corporations.
- Nonprofit corporations.
- Professional corporations.
These can be further broken down into privately and publicly held corporations. The most common ones in the United States are C and S corporations.
Key Characteristics of C Corporations
If you opt for a C corporation, the business can be owned by an unlimited number of domestic and foreign stakeholders. They will form a board of directors to make decisions and manage the company's day-to-day operations. Stakeholders are free to buy or sell shares and have limited liability.
This type of legal entity is subject to double taxation, meaning that it pays tax on profits and its shareholders pay taxes on dividend earnings, which are reported on their personal tax returns. Basically, the company's revenue is taxed at both the personal and corporate levels. For this reason, smaller companies prefer to form S corporations or LLCs.
Besides double taxation, this legal structure comes with many other challenges. C corporations are required to file articles of incorporation, choose a board of directors, have written bylaws, hold regular meetings and submit annual reports to the secretary of state. Additionally, they are expensive to start and maintain. You will need to hire lawyers and accountants and pay annual reporting fees and higher taxes than an S corporation.
How Do S Corporations Work?
S corporations are similar to partnerships and enjoy special tax provisions. Unlike C corporations, they're not subject to double taxation. The company is not taxed separately from its stockholders. This means that its earnings and losses are reported on the shareholders' personal tax returns. The downside is that there are more restrictions in place.
First of all, the company can only have 100 domestic shareholders that must be individuals, estates or trusts, not corporations. Plus, it can have only one class of stock. C corporations, on the other hand, may have several types of stock.
The strict qualification requirements associated with S corporations may limit your ability to do business. However, this legal structure remains a preferred choice for smaller companies that want to avoid double taxation and handle less paperwork.
Nonprofit Corporations at a Glance
Business owners may also form nonprofit corporations, which enjoy tax-exempt status. This type of legal entity is incorporated for purposes other than making profits. Membership clubs, credit unions, political organizations and charities are just a few examples.
Nonprofit corporations can receive donations and don't pay state and federal taxes. Additionally, its board members are not personally liable for any debts or losses. The organization can apply for grants to support its mission and projects. If it ceases to exist, its assets must be given to other charities.
You still need to hire an accountant and attorneys, keep detailed records and have written bylaws. These are common attributes of a corporation, whether it's profit or not.
The Advantages of Professional Corporations
Both S and C corporations can register as professional corporations (PC) with the secretary of state. These organizations consist of doctors, attorneys, engineers and other licensed professionals. The shares can only be transferred to individuals who practice the same profession as the company's stockholders. A law firm, for example, cannot sell shares to a medical practice.
Many business professionals choose this legal structure because of the limitations on member liability. Additionally, they can take tax deductions for fringe benefits like dependent care and disability insurance. Professional corporations also pay less in tax and can provide retirement plans with higher contribution limits than those available to other business entities.
Why Form a Corporation?
Now that you know the characteristics of a corporation, you might wonder whether or not it's right for you. Even though this legal structure requires more time and money, it has its perks. A major advantage is that its shareholders are not liable for the company's losses and debts. Additionally, corporations may sell shares to raise capital and expand their operations. Furthermore, the benefits provided to their employees are deductible.
Another advantage is that the company's ownership can pass from one generation to another. Other business entities cease to exist when their founders die. Plus, it's easier for a business with an INC. extension after its name to build trust and credibility, secure funding and build a strong brand.
The downside of forming a corporation is that you'll be dealing with a substantial amount of paperwork. Depending on the type of corporation you choose, you may be taxed twice. Be prepared to keep detailed records of your tax returns, annual reports, business licenses and permits, shareholder meetings, personal and business bank accounts and more.
Compared to LLC, corporations are governed more formally and require more paperwork. On the other hand, they find it easier to obtain financing and can offer stock options as incentives to managers and employees. Both legal structures have their pros and cons. Before you make a decision, discuss the structure and features of the corporation with a lawyer or tax consultant. They can explain you the ins and outs of owning this type of business, its costs and what to expect.
You may also research big corporations to see how they operate. Verizon Communications, General Electric, CVS Health and Apple are just a few to mention. Also, look up the corporate laws in your state in order to make the right choice.
- US Legal: Laws Governing Corporations
- INC: Double Taxation
- Upcounsel: C Corporation Disadvantages: Everything You Need to Know
- Wolters Kluwer: S Corporations Offer Advantages - And Disadvantages
- Entrepreneur: Nonprofit Corporation
- Grantspace: What Are the Advantages/Disadvantages of Becoming a Nonprofit Organization?
- Legal Match: What Is a Professional Corporation?