A corporation is a legal entity of its own; thus, its owners (shareholders or stockholders) aren’t personally liable for the business’s liabilities, losses, and risks. Shareholders can come and go, but, unlike a sole proprietorship or a partnership, the business will continue to exist in spite of any change in the corporation’s ownership.
With this protection, shareholders enjoy important rights like receiving dividends as a result of profits and price appreciation from successful business endeavors. In addition to these benefits, limited liability means that they are not personally liable for payment of the company’s debts.
Almost every well-known company and brand in the world is a subsidiary of a corporation. These include such well-known brands as Coca-Cola, McDonald’s, Microsoft, and Toyota Motors. Corporations can also operate under a different name.
Alphabet Inc. as the operator of Google is a good example. Corporations are formed when a group of shareholders decides to create one. They pursue this goal after achieving a common goal in their business ownership. Such corporations can be both non-profit and for-profit.
The vast majority of such corporations are formed with the goal of providing positive returns to shareholders. In return for paying in their shares, these shareholders receive a share in the company.
If they receive it directly from the company, their payments go into the company’s coffers. Companies can have thousands of shareholders, especially if they are listed on a stock exchange.
However, these companies may also have few or no shareholders. “C corporations” are the most common form of corporation in the United States. Each year, shareholders elect the company’s board of directors with their one vote per share.
This group is responsible for appointing management, which they oversee. The managers are responsible for the day-to-day operations of the company. The company’s board of directors is responsible for implementing the business plan.
They are also not liable for the company’s debts, but have a fiduciary duty to care for the company. If they do not perform their duties diligently, they can be held personally liable for mistakes. There are tax laws under which board members can be held personally liable.
When these companies have achieved their objectives, they can be dissolved in a so-called liquidation procedure. In this process, a liquidator is appointed who sells the company’s assets, pays the creditors and distributes the remaining cash to the shareholders.
This can be done either through involuntary or voluntary proceedings. If a company is unable to pay its debts, creditors may force liquidation. This often leads to the bankruptcy of the company.
The Creation of a Corporation
A corporation is created when it is incorporated by a group of shareholders who share ownership of the corporation, represented by their holding of stock shares, and pursue a common goal.
The vast majority of corporations have a goal of returning a profit for their shareholders. However, some corporations, such as charities or fraternal organizations, are nonprofit or not-for-profit.
In any case, their shareholders, as owners of the corporation, do not accept responsibility for it beyond the potential loss of their investment in it.
A private or “closed corporation” may have a single shareholder or several. Publicly-traded corporations have thousands of shareholders.
In the U.S., corporations are created under the laws of the individual states and are regulated by state laws. Public corporations are regulated by federal law, primarily via the Securities and Exchange Commission.
Becoming a Corporation
Every state has its own laws regarding incorporation.
Articles of incorporation must be filed with the state and then stock is issued to the shareholders. A board of directors must be elected annually by the shareholders.
Transforming a private company into a public company is a more complex process, as the process falls under federal laws that require full and public disclosure of financial information to potential shareholders and the government.
Types of Corporations
If you decide to incorporate, you have four kinds of corporations to consider: the C Corporation, the Subchapter S Corporation, the limited liability corporation, and the B Corporation. We discuss each one below:
Most big businesses and some small corporations elect C, or regular, Corporation status, primarily because of their need for the liability protection that C Corporations offer. Because of their size and the public nature of their business, these large corporations don’t qualify for either Subchapter S or limited liability company status.
A C Corporation is taxed as an entity separate from any of the individuals comprising it, and all the profits of the business are taxed at the corporate level. If some of those profits are paid in dividends to the corporation’s shareholders, the shareholders have to pay ordinary income tax on those dividends, too. The result is the so-called double-taxation status of corporations.
As with the other types of corporations, C Corporations are expensive and time-consuming to create. The process includes getting the owners of the business (the shareholders and stockholders) to agree on the following:
- The name of the business.
- The number of stock shares the company can sell, the class of stock, and its value.
- The number of shares the owners will buy.
- The amount of money (or other assets) the owners will contribute to buy shares of stock.
- The directors and officers who will manage the corporation.
Subchapter S Corporations
Named after the Internal Revenue Code section that allows them, Subchapter S Corporations are the “little folks” — smaller companies that need the liability protection afforded but don’t have the issue of multiple shareholders to worry about. Subchapter S status is reserved for businesses with no more than 75 shareholders. Both new and existing businesses may elect to adopt Subchapter S status.
When does becoming an S Corporation make sense?
As with a C Corporation, an S Corporation provides the liability protection, but unlike a C Corporation, it avoids the double-taxation status by allowing the income of the corporation to pass through to its owners/shareholders. So the major difference between an S Corporation and a C Corporation is that the S Corporation income is subject to only one tax — the personal income tax.
S Corporation status is the usual choice of small-business owners who make the decision to incorporate for liability purposes. This is especially true for start-up businesses because early-stage losses can be offset against your personal income.
Before deciding to create a Subchapter S Corporation, consider the profitability expectations of your business. In the start-up years, if you’re like most small businesses, you can expect your business to lose money. In this case, opting for Subchapter S status is advisable, because you can offset your business losses against your personal income. In later years, as your business becomes profitable, paying taxes at the corporate rate rather than the personal rate may become more advantageous, so you’d be wise to switch to C Corporation status.
The election of Subchapter S status has many other varied ramifications. We strongly recommend that you have an attorney or qualified tax advisor help you make this decision.
Limited liability companies: A hybrid invention
The limited liability company (LLC) is the newer kid on the corporate block. The IRS officially awarded the LLC favorable tax status in 1988; today, all 50 states and the District of Columbia allow this unique entity. An LLC is a hybrid entity. It combines the benefits of a corporation with those of a partnership:
- As in a corporation, investors in an LLC don’t face personal liability for the debts or obligations of the LLC.
- Like a partnership, the LLC is afforded favorable tax treatment because the income and losses of the business flow through to the individual investors, who are called members, and are reported only once on each investor’s personal income tax return.
Another advantage of an LLC is its flexibility. Unlike an S Corporation, an LLC can be structured to allocate the profits of the business differently among the various members, while at the same time preserving the flow-through tax treatment. An LLC has the added advantage over a partnership of providing the members with limited liability.
LLCs are relatively new, so we recommend that you consult an attorney with significant experience in establishing LLCs for small businesses like yours to help you decide whether an LLC can work for your business and to help draft the operating agreement. Find an attorney who really understands the ins and outs of LLCs and ask for attorney referrals from other business owners who’ve incorporated.
A B Corporation, otherwise known as a “B Corp” or “Benefit Corporation,” is a for-profit business entity whose mission includes having a material, positive impact on society and/or on the environment. Or, stated another way, a B Corp’s purpose in life is “to do good while doing well.”
The primary benefit of becoming a B Corp is to officially brand your business as one that benefits society. By branding yourself as a B Corp, you may better attract that segment of customers and investors who find it rewarding to invest in or be a customer of businesses with a social conscience. Patagonia and Toms Shoes are two prominent examples of B Corps.
Becoming a B Corp requires a rigorous application and approval process. Also, as of this writing, not every state recognizes B Corps. Check with your state’s Attorney General to find out whether your state is included (you can locate your state’s website through The National Association of Attorneys General at http://www.naag.org/). Also check out the useful website https://www.bcorporation.net/ to learn more about B Corps.
What Is a Corporation vs. a Business?
Businesses are often corporations, but not all of them.
Any business or enterprise may seek incorporation. Corporations exist as separate legal entities from their owners. In the end, this means that the owners are not responsible for the corporation’s debts. In addition, the corporation can own assets, sue and be sued, and borrow money.
Limited Liability Company vs. Corporation: What’s the Difference?
Corporations and limited liability companies (LLCs) offer similar legal advantages and protections to their owners. In particular, neither entity’s owners can be held liable for the debts of the other.
Some businesses benefit from the tax advantages of LLCs. Their taxes are “pass-through.” This means that the LLC pays taxes on profits rather than the owners.
Other key differences include:
The roles and responsibilities of LLC members are outlined in an operating agreement. LLCs are often made up of lawyers or doctors who share a practice. Many big businesses, such as Anheuser-Busch, are LLCs as well. Setting up an LLC is relatively simple.
A corporation elects its board of directors, holds annual meetings, and adopts its bylaws. Depending on the state in which the company is incorporated, the process may be long and complex.
The Day-to-Day Operations of a Corporation
As a rule, the shareholders of a stock corporation have one vote per share.
Its board of directors is elected at an annual meeting. The board of directors is responsible for the day-to-day operations of the company and hires and supervises its management.
A corporation’s business plan is implemented by the board of directors. Although board members are not personally responsible for the corporation’s debts, they still have a duty of care to the corporation and can be held personally liable if they breach that duty.
A number of tax laws also provide for the personal liability of the board of directors.
Liquidating a Corporation
Liquidation is a process that ends the legal existence of a corporation. There may be a voluntary decision to cease operations or the business may be forced to cease operations as a result of financial collapse.
Companies appoint liquidators who sell the corporation’s assets. Any remaining money is distributed to shareholders after creditors are paid.
Liquidation by involuntary default is usually triggered by a corporation’s creditors. A bankruptcy filing follows if the situation cannot be resolved.