6.04 – Going for Gold
Going for the Gold: The Corporation
A corporation is a legal entity with continuity of life, allowing it to survive the death or separation of its owners. Chartered or registered by the state in which it resides, a corporation can sue, be sued, acquire and sell real property, and lend money.
Corporation owners, known as stockholders, invest capital and receive shares of stock, usually proportionate to their investment. Much like limited partners, shareholders are not responsible for the corporation’s debts (unless personally guaranteed) and their liability is limited to their investment.
This lesson covers two major types of corporations: the C Corporation (closely held, close, and public) and the S Corporation. Most corporations are C Corporations and are closely held, meaning stock is held privately by a few individuals. A closely held corporation operates like any other corporation – general, professional, or nonprofit. In a close corporation, the number of shareholders is usually restricted to between 30 and 50. Directors’ meetings, required for an S Corporation, are not necessary for a C Corporation. However, C Corporations are not available in every state and do not permit conducting an initial public offering. Essentially, a close corporation operates much like a partnership.
Professionals such as doctors, lawyers, and accountants often use professional corporations, allowing them to enjoy tax-free and tax-deferred fringe benefits. Only members of the specific profession can be shareholders, and all shareholders are liable for negligent or wrongful acts of any shareholder.
In contrast, a public corporation trades stock on securities exchanges like the New York Stock Exchange and generally has thousands or millions of shareholders. For simplicity, this lesson focuses on C Corporations, as most new businesses choose this type.
Understanding Corporate Structure
Three groups of individuals make up the corporate structure: shareholders, directors, and officers. Shareholders own the corporation but do not manage it. They exert influence through elected directors who represent them on the board. The board of directors manages the corporation’s affairs at a policy level and hires and fires officers responsible for day-to-day operations.
Public corporations in most U.S. states require only one director, though some states require more based on the number of shareholders. If forming a corporation outside the U.S., check local government requirements for boards of directors.
In the U.S., corporations, though a small minority of businesses, generate most sales. Entrepreneurs intending to grow their companies often choose the corporate form for its many benefits.
Enjoying the Benefits of a Corporation
The advantages of a corporate form outweigh the disadvantages. Owners enjoy limited liability to the extent of their investment (with the exception of unpaid payroll taxes to the IRS). Additional benefits include:
- Raising capital through the sale of stock.
- Owning a corporation anonymously.
- Creating different classes of stock to meet investor needs.
- Easily transferring ownership.
- Entering into corporate contracts and suing or being sued without owner signatures.
- Enjoying more status in the business world as corporations survive apart from their owners.
- Setting up retirement funds, Keogh and defined-contribution plans, profit sharing, and stock option plans. These fringe benefits are deductible expenses that aren’t taxable to the employee.
Weighing the Risks
Every legal form has disadvantages and risks, and corporations are no exception:
- Corporations are more complex, cumbersome, and expensive to set up.
- Subject to more government regulation.
- Pay taxes on profits regardless of distribution as dividends.
- Shareholders of C Corporations don’t receive tax benefits for company losses.
- Selling shares of stock means giving up some control to a board of directors. However, entrepreneurs usually determine who sits on the board in privately held corporations.
- Personal and corporate finances must be kept separate, and directors' meetings with minutes must be maintained. Failure to do so can result in piercing the corporate veil, making officers personally liable for company actions.
Deciding Where and How to Incorporate
Create a corporation by filing a certificate of incorporation with the state where you do business and issue stock, making your company a domestic corporation. Incorporating in a state other than where you do business makes it a foreign corporation.
Generally, it’s best to incorporate in the state where the business will be located to avoid working under regulations from two states. Consider the following:
- The cost difference of incorporating in your home state versus doing business as a foreign corporation in another state. Incorporating in your home state usually avoids taxes and fees from both states.
- The advantages and disadvantages of the other state’s corporate laws and tax structure. For example, some states impose a minimum state tax regardless of profit, while others do not. Incorporating outside your home state may also incur travel expenses if you need to defend a lawsuit in the state of incorporation.
In summary, while incorporating as a corporation offers many benefits, it’s important to weigh the risks and understand the requirements to make an informed decision that aligns with your business goals.
