What is a corporation?
A corporation is a legal business entity created by stockholders, shareholders, or individuals to operate for profit. This business structure is also subject to corporate law. Like individuals, corporations are permitted to undertake contracts, own assets, sue and be sued, pay taxes, limit state and federal taxes, and loan funds from banking institutions.
Creating a business corporation takes into account incorporation, which is a legal process. This process requires legal documents encompassing the main purpose of the business, the corporation’s location and name, the number of dividends, and the class of stock issued to be drafted.
Incorporation ensures that the business entity’s owners are protected from personal liability in the event of a legal claim or lawsuit.
Most large businesses are corporations, including companies like Coca-Cola Co., Microsoft Corp., and Toyota Motor Corp. While some corporations conduct business under their names, many corporations operate under a separate business name, such as Alphabet Inc., which does business as Google.
Common types of corporations
Corporations are formed when multiple shareholders unite to seek a common goal; however, a single shareholder can create a corporation. Additionally, a corporation may be created as a for-profit or not-for-profit entity.
The larger number of corporations are for-profit entities, and these corporations are created to bring in revenue and issue profits to shareholders based on their portion of proprietorship within the company.
Charitable organizations function under the classification of not-for-profit entities. They are committed to a specific communal objective such as scientific, religious, educational, or research initiatives. Not-for-profit entities use their revenue to advance their goals rather than distributing the revenue to shareholders.
1. C Corporation
The most common structure of incorporation is C corporations. They contain nearly every hallmark of a corporation. Corporation owners are taxed at the individual or independent level and receive profits, and the corporation is taxed in the same way as a business unit.
2. S Corporation
While an S corporation is formed similarly to a C Corporation, tax purposes and owner restrictions differ. An S corporation is not taxed as separate and is made up of no more than 100 shareholders. These types of business units must also file with the IRS to get their status. In comparison to the C Corporation structure, S corporation profits and losses are carried by the owners on their income tax returns.
3. Nonprofit corporation
Religious, educational, and charitable organizations typically use nonprofit corporations to function without bringing in profits. Therefore, a nonprofit corporation is absolved from taxation. All donations, contributions, or funds received by the nonprofit corporation are cycled back into the business to spend on the nonprofit organization’s expansion, future plans, or operations.
When to form a corporation?
Small business owners have the most to gain by forming a separate legal entity to protect their personal assets. The protection of personal assets is referred to as limited liability protection and ensures that business owners cannot be held personally liable in the event of bankruptcy or a lawsuit.
Limited liability protection becomes available when you form a limited liability company [LLC] or corporation.
If your small business or start-up plans to rely on investors, then corporations are an excellent choice. Most investors prefer corporations due to how corporate profits are taxed compared to LLC profits.
How to start a corporation
Starting a corporation includes the steps listed below:
1. Select a name for your corporation
An important first step is choosing a business name for your corporation. As is the case when starting any business, a business name reflects your company’s brand and identity, requiring careful consideration.
General corporate name guidelines
When deciding on the corporate name for your business, keep the following in mind:
- The business name must not include words such as treasury, FBI, State Department, etc. that may confuse a corporation with a government agency
- The business name must not contain the words of trustee, trust, bank, or credit union without approval
- The business name should be distinguishable from other business entities in the state, including the state’s reserved names
- The business name must include a designation such as Inc., company, corporation, limited, or abbreviations of any of these terms
2. Nominate a registered agent
Upon registering your corporation with the state, you need to appoint a registered agent. They have one primary goal: to receive service of process, compliance documents, and government correspondence on behalf of your corporation.
You may nominate an individual or business entity to serve as your corporation’s registered agent.
3. Hold an initial organizational meeting
You need to hold an organizational meeting prior to filing the formation documents. During your corporation’s first meeting, the board will need to complete a few tasks including creating and approving bylaws, issuing stock certificates to shareholders, and determining the share structure.
4. File Articles of Incorporation
The next step involves the filing of formation documents with the relevant Secretary of State website. Your corporation will have officially been formed once the documents are approved. Formation documents can be found online in most states, and if not, you are required to draft your own formation documents.
5. Create and approve bylaws
The bylaws may be referred to as a Constitution for your corporation. This is because they contain rules that outline how your corporation is going to be governed and operated. The bylaws essentially clarify the priorities and rules for everyone involved in the corporation.
6. Appoint initial directors
The required number of directors as per the state must be appointed until the first shareholders’ meeting is held.
A corporate director is in charge of the amendment, adoption, and repeal of operational bylaws in addition to the supervision, election, and removal of officers.
Once your corporation has been formed, the initial directors or incorporators should call an organizational meeting. During this meeting, the board of directors and officers will be appointed.
7. Select a strategy and share the structure
The unit of ownership of a corporation is the share of stock. Each share of stock represents a percentage of ownership of the corporation. That is, in the event that the corporation issues only one share of stock, the shareholder or stock owner owns 100% of the company.
8. Create and implement an incorporator’s statement
An incorporator’s statement must be signed and completed by the incorporators. It should include the addresses and complete names of each initial director. Therefore, these details must be stored in the corporate records.
9. Obtain an EIN
An EIN is an Employer Identification Number assigned to all business entities in each state. The EIN is obtained from the Internal Revenue Service completely free of charge when you complete the IRS Form SS-4. The quickest way to obtain your Employer Identification Number is to apply online using the EIN assistant.
Advantages of starting a corporation
While many business owners are under the impression that incorporation is a time-consuming and costly affair, neither is the case. In fact, the benefits gained by entrepreneurs by establishing their business as a corporation outweigh possible disadvantages.
Incorporation benefits include:
- Tax advantages – Corporations enjoy various financial privileges like the deduction of health insurance installments paid on behalf of an owner-employee. When it comes to self-employment taxes corporations also save because corporate income is not liable to medical taxes, Social Security, or workers’ compensation. Corporate profits are taxed at a lower rate than personal income tax rates.
- Limited liability – A corporation offers limited liability protection to shareholders. Creditors cannot pursue the owner’s personal assets due to the fact that owners are not personally responsible for the debts and liabilities of the business. Therefore, personal properties such as houses, cars, and personal assets are off-limits when you incorporate as a corporation. This is one of the biggest advantages of forming a corporation compared to a general partnership or sole proprietorship business structure where both the businesses and the owners are held legally liable to pay business debts even if it means sacrificing their personal assets.
- Unlimited life – Another major advantage of incorporation is that a corporation’s life does not depend upon its owners. In other words, a corporation has an unlimited life, and even if the owner passes on or chooses to sell his or her interest, the corporation will resume and conduct business as usual.
- Raising capital – Capital is raised easier through the sale of stock. Therefore, when providing small business loans, many banks want the borrower to be an incorporated business.
Maintaining a corporation
After incorporating a corporation, you also need to comply with the relevant laws that are akin to the following:
- Securities: Corporations are required to issue stock as their Articles of Incorporation mandate and security laws
- Taxes: All corporations must file their annual tax returns
- Bookkeeping: All corporations are required to not only establish but maintain the books and records, which include corporate minute books, shareholder records, and financial accounts
- Meeting minutes: Aside from holding board meetings, corporations are also required to keep official records of all actions and decisions put forward and resolved in the meetings
- Board meetings: All corporations are required to hold an initial board meeting that involves both the shareholders and directors; thereafter, successive board meetings should be held no less than once per year
- Licensing: Depending on the scope of your corporation and the structure you opted for, you may need to meet licensing requirements such as annual renewal and fees
- State registration: All corporations are required to sustain their annual enrollment with the state. Annual fees are compulsory.
Liquidating a corporation
It is possible to end a corporation’s legal existence, and this process is referred to as liquidation or dissolution. In most cases, this decision is influenced either by the financial collapse of a corporation or a voluntary decision to cease operations.
In most cases, a liquidator is appointed by the Board of Directors, and this person is responsible for selling the corporation’s assets. Thereafter, the funds are used to pay off creditors and distribute the remaining funds to existing shareholders.
When creditors of a corporation fail to pay their dues, it triggers an involuntary liquidation. If the situation cannot be resolved, then filing for bankruptcy is the most likely outcome.
The bottom line
While each state has its own laws regarding forming a corporation, most states require that owners file Articles of Incorporation with the state in question and then issue stock to the company’s shareholders. The board of directors needs to be elected by the shareholders in an annual meeting. The board of directors then oversees the corporation’s daily operations management.
The five primary steps to starting your corporation include:
- Selecting a name for your corporation
- Choosing the registered agent
- Holding an organizational meeting
- Filing formation documents
- Obtaining an Employer Identification Number
A nonprofit corporation is a legal entity incorporated under the law of its jurisdiction and is designed to improve the quality of life for humanity or the natural world. Consequently, nonprofit organizations do not make profits that are distributed to shareholders; however, the money brought in is used to further the cause.
Corporations must pay between $50-$200 in the form of government filing fees. Additionally, filing fees are to be paid to the Secretary of State. The filing fees paid all depend on the type of business being formed and the state in which the business is incorporated.
One or more individuals own LLCs while corporations are owned by their shareholders. However, both types of business structures offer business holders and shareholders advantages.
A corporation is considered a legal entity, and this means that it’s separate from its owners, who are called stockholders or shareholders. A corporation is treated as a person or individual with most of the obligations and rights of a real person. Therefore corporations are not allowed to hold public office or vote; however, they are required to pay income taxes.