What is a Corporation | Everything You Need to Know Before You Incorporate

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A corporation is a business organization similar to an LLC in many ways. But what exactly makes a corporation distinct, let’s discover in detail.

If you’re thinking of starting a corporation, it’s essential to understand its potential benefits and how it is different from other business entities. For guaranteed success, you need to find that balance between legal protection while still taking advantage of all potential benefits.

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Whether you choose to operate as an LLC or are inclined towards working as a corporation, any business structure you choose can have a significant impact on the day-to-day business operations.

So be it the taxes you pay or the risk of personal assets being at stake, choose your business structure wisely.

Usually, small businesses choose to be a corporation to get limited liability protection and attract investors.

What other benefits does a corporation offer? Learn more about what a corporation is, how it works, the advantages and disadvantages of a corporation, and more. Keep reading.

What is a Corporation?

A corporation is an independent legal entity that is separate from its owners.

It is created by stockholders, individuals, or shareholders, with the intent to generate profit. Being an entity, a corporation has many rights similar to an individual.

It means that corporations are legally entitled to enter into contracts, borrow money from financial institutions, own assets, sue and be sued, remit federal and state taxes, etc. A corporation is sometimes referred to as a legal person in a legal and business community.

Why Choose a Corporation for A Small Business?

Before deciding which type of business structure to create, it’s best to weigh out all options and determine the best fit for your business’s personalized needs.

For instance, does your business plan rely on investors? Are you planning to expand your business? Are you looking to protect yourself from liabilities? Having these questions in mind, choose a corporation if:

  • You want to shield your personal assets from legal claims and lawsuits by getting limited liability protection.
  • Your business plans mostly rely on investors.
  • You want your business to continue to operate without any disturbance If a shareholder sells his/her shares or leaves the company.

Advantages and Disadvantages of Incorporation

We all know nothing comes 100% perfect and tailor-fit to your personalized needs. You like some parts of a business structure and may dislike some.

Well, you need to adopt a business structure that has more advantages than disadvantages given to your situation. Here are some pros and cons of a corporation given below:

Advantages of a Corporation

  • Limited liability Protection: Lenders and creditors have no claim to the shareholders’ personal assets for payments owed by the corporation. The shareholders are only liable for the amount they invested.
  • Separate legal entity: Corporations are independent legal entities that may borrow money, pay taxes, conduct business, enter into binding contracts, own properties, sue, and be sued.
  • Easy transfer of ownership: Publicly held corporations do not need other stockholders’ permission to sell the shares or stocks of individual owners. Regardless of their volume, corporations’ shares or stocks can be easily traded in the market.
  • Unlimited life: Corporations are managed by a board of directors. Suppose the owners of a corporation, such as shareholders, stockholders, or members, cannot perform their duties, or any of them dies. In that case, it does not affect the continuity of the corporation’s legal entity. To extend or liquidate a corporation, only changes in the company’s charter will be needed.
  • Funding and capital source: By selling stocks and issuing bonds, corporations can easily source funds.
  • Competent management: The day-to-day business operations of a corporation are usually not directly handled by its investors or owners. The owners vote for the board of directors, who are responsible for hiring a professional management team.

Disadvantages of a Corporation

  • Double taxation: Corporations pay double tax. One is corporate-level tax remitted from the corporate earnings, and the other is from payments of dividends to shareholders.
  • Incorporation costs: It costs you more to go through the incorporation process than forming a sole proprietorship or partnership.
  • Documentation and corporate formalities: Corporation must file annual reports and tax returns, hold periodic board meetings and record minutes, maintain licenses and accounting records, and other important documents.

Tax Options for Corporations 

Tax flexibility is one of the major reasons that start-ups choose a business structure. After all, who wants to pay unnecessary tax and small businesses continuously look for tax write-offs.

If you wish to opt for a corporation, keep in mind three tax options available for corporations.

  1. IRS taxes C corp as a default corporation. Therefore C corps are subjected to double taxation. The corporation is taxed at a current 21% rate on its profits. The shareholders are also taxed on the dividends they receive from the corporation.
  2. To avoid double-taxation, a corporation can elect to be taxed as an S corp. In addition to avoiding double taxation, an S corp tax model also allows the business owner to negate the investor benefits offered by corporations.

 Pro Tip: If you are operating as an LLC, you can elect to be taxed as an S corp by the IRS.

3. Nonprofit corporations are usually exempt from the tax. This is done by registering as a 503(c) nonprofit corporation with the IRS.

LLC VS Corporation

Once you conceptualize a business idea and are ready to materialize it, one of the first decisions you’ll have to make is choosing an entity type.

Though many business structures provide limited liability protection, generally, entrepreneurs and start-ups choose to form a Limited Liability Company (LLC) or a corporation.

The following are some differences between LLC and corporation that will help you decide which structure you should opt for:

  • LLCs are a low-cost way to form an entity than a corporation.
  • Corporations can more easily obtain investment capital than LLC.
  • An LLC can allocate different voting rights to members, but in corporations, the case is different.
  • Some corporation types, such as S corp, have restrictions on ownership, while LLC does not have such restrictions.
  • Corporations are also obligated to have more extensive record-keeping and reporting.
  • Both Corporation and LLC have different management structures.
  • Corporations have to go through more formalities and operational processes than LLC.

Types of Corporations

A corporation is a legal entity created by an individual (single shareholder) or a group of shareholders with a shared goal. Generating profit is not always the case.

Corporations are formed as for-profit corporations, the most common type of corporation, and not-for-profit corporations.

Corporations serve as a popular business model since it offers a lot of flexibility by having different types that can fit the personalized needs of business owners. Here are the types of a corporation:

1. C Corporation

C Corporation, aka C Corp, contains almost all of the attributes of a corporation and is the most prevalent type of corporation.

It can be a perfect choice for businesses that need to raise money, medium- or higher-risk businesses, or businesses that plan to “go public” or eventually be sold. Here is how C corp is different from the other types of corporations:

  • C corps are subjected to double taxation, meaning that the taxing of business profits is at both personal and corporate levels. The corporation itself is taxed as a business entity, and shareholders are taxed on the profits they receive at the individual level. 
  • Unlike S corporations, C corporations do not have any restriction on the number of owners. However, upon reaching specific thresholds, C corps must register with the SEC (Securities and Exchange Commission).
  • C corporations can raise capital because they can raise funds by selling their stocks. 

2. S Corporation

S corporation, aka S corp, is formed in a similar way as a C corporation but is different in tax flexibility and owner limitation. The following points make S corp different than the other corporation types:

  • An S corp has a limitation on the number of owners and can have up to 100 shareholders.
  • S corp is not taxed as a separate entity. Instead, the profits and losses are passed through on the personal income tax returns of shareholders.
  • S corps have to go through a different process from registering with their state to getting S corp status. They must file with the IRS to elect the entity as S corp.

3. B Corporation

B corporation, aka B corp or benefit corporation, is a for-profit corporation that many states in the U.S. recognize.

Based on the purpose, transparency, and accountability, B corps are different from C corps. However, B Corps are taxed the same as C corps. Some of the salient features of B corp are:

  • B corps do not require third-party B corp certification services to be legally considered a B Corp in the states where the legal status is available.
  • B corps are driven by both profit and mission. 
  • In addition to a financial profit, shareholders hold the company accountable to produce some sort of public benefit. 
  • In some states, B corps must submit annual benefit reports demonstrating their contribution to the public good.

4. Close Corporation

Close corporations are similar to B corps but enjoy the flexibility in the traditional corporate structure. Here is how close corporations are different from other corporation types:

  • Many formalities that typically govern corporations and apply to smaller companies, close corporations are exempted from those. 
  • Shares of close corporations are usually barred from public trading. However, rules vary from state to state.
  • Close corporations can be run by a small group of shareholders without a board of directors.

4. Cooperative Corporation

A cooperative corporation, aka co-op, is a democratically run business whose members are also its owners.

A co-op is a business or organization owned by and operated to benefit those using its services. Here are prominent features of a cooperative corporation:

  • Other types of corporations are owned by shareholders or stockholders, while cooperatives are owned by their members or the people using the services of the cooperative.
  • Profits and earnings generated by the cooperative corporation are distributed among the members, aka user-owners. 
  • Typically, a cooperative is run by an elected board of directors and officers. On the other hand, regular members of the cooperative have the voting power to control the direction of the cooperative. 
  • By purchasing shares, members can become a part of the cooperative. Moreover, the amount of shares does not affect the weight of a regular member’s vote.

5. Non-Profit Corporation

Nor-profit corporations are also known as 501(c)(3) corporations. This structure is commonly used by charitable, religious, and educational organizations to operate without generating profits.

Nonprofit corporations need to follow organizational rules very similar to a regular C corp. Here is what make non-profit corporations different from for-profit corporations:

  • A non-profit corporation is exempt from taxation.
  • In addition to the state registration process, non-profit corporations must file with the IRS to get tax exemption. 
  • Any donations, contributions, or revenue received by non-profit corporations are retained in the entity and are spent on expansion, operations, or future plans.
  • Non-profit corporations, in addition to corporate rules, also need to follow special regulations related to the profits they earn. For instance, they can’t distribute profits among members or political campaigns.

Understanding Corporations | How Do Corporations Work?

Well, all big names in the business, such as Microsoft Corp., Amazon Inc., the Coca-Cola Co., Apple Inc., Toyota Motor Corp, etc., operate as corporations.

Like other formal business structures, corporations also have a distinct structure and specific regulations that they need to follow. Wondering how corporations work? Let’s skim through it.

Corporate Bylaws

Corporations’ bylaws, aka a corporation’s constitution, set out the rules and priorities for everyone involved in running the corporation. In other words, bylaws are prewritten rules that guide how a corporation will be run and governed.

Pro Tip: It is generally perceived that you may need an attorney to draft your corporate bylaws. However, many incorporation services such as ZenBusiness and IncFile offer a free draft of bylaws in their formation packages. So, you do not need to spend hundreds of bucks in the name of attorney fees to get bylaws for your corporations.

Corporate bylaws supplement any federal or state law set forth to govern formal businesses.

Moreover, bylaws determine what will be done if a corporation faces unforeseen circumstances. Generally, corporate bylaws must include the following information:

  • How the day to day operations of the corporation will be conducted
  • The way the corporation will issue stock
  • How meetings are held and detail of voting procedures
  • Method of electing officers or directors
  • Define quorum for voting purposes
  • How the corporation will be governed, including the role of officers and directors
  • The layout of executing legal documents
  • The process of keeping and managing the corporate records 
  • The date of the annual shareholders’ meeting
  • How disputes will be handled
  • How to negotiate contracts
  • The method of future amendments in bylaws 
  • Fiduciary duties (i.e., acting in the best interests of the corporation) to the corporation 
  • Who is entitled to file annual reports

Board of Directors

Corporations are formed by state law and are required to appoint a certain number of directors until their first shareholders’ meeting.

A corporate director is in charge of the amendment, adoption, and repeal of corporate bylaws. Moreover, a director is responsible for overseeing the officers’ election, supervision, and removal.

Some corporations name their initial director(s) “the incorporator” on the formation documents. They’re responsible for filing the articles of incorporation with the state. Without an incorporator, a corporation can not be fully incorporated and legally registered.

The incorporators are responsible for calling an organizational meeting. They officially elect the board of directors or appoint the officers in that meeting.

Shares and Shareholders

The unit of ownership of a corporation is called the share of stock. The shares of stock represent the percentage of ownership of the company.

For instance, if a corporation issues one share of stock, then the stock owner, aka shareholder, will own 100% of the corporation. 

A corporation is allowed to issue a certain number of stocks (predefined in the bylaws). The number of shares the corporation is allowed to issue is known as Authorized Shares. The total number of shares that the corporation issues to shareholders are called Issued Shares.

Shares can be structured into classes. Each share class may hold a unique set of rights and privileges. There can be multiple classes in a corporation, and each class can hold any number of shares.

Corporate Taxes

The profits of a corporation are distributed among shareholders in the form of dividends. The IRS then taxes shareholders on this dividend. Therefore, the total tax amount depends on the dividends that the shareholders receive.

The tax rate on ordinary dividends is the same as the individual federal income tax rate. The current federal corporate tax rate is 21%.

Double Taxation

A corporation is usually subjected to double taxation. It means that a corporation pays tax as an entity at the corporate level, and the shareholders of the corporation pay tax on the dividends they receive.

Pro-Tip: Many small businesses and start-ups create an LLC due to tax flexibility and low formation cost to avoid double taxation.

A corporation has two options while paying its taxes. It can opt to be taxed as an S corporation (S corp) or a C corporation (C corp). On the other hand, LLCs offer more tax flexibility to their members than corporations.

Corporate Law and 

Corporations are legal entities and protect their owners’ personal assets from creditors of a corporation, debts owed by the corporation, and lawsuits brought against the corporation. 

Corporate laws are there to regulate the funding, formation, operations, governance, and dissolution of a corporation. Corporations are governed by:

  • Federal laws 
  • State laws
  • Securities and Exchange Commission (SEC)

The SEC protects investors while maintaining fair markets for all businesses and supporting capital formation.

Why Corporations Attract Investors

Investors prefer corporations because they are only taxed on the dividends (distributions) they receive from the corporation. 

On the other hand, the members of an LLC are taxed on their portion of the profit that is based on ownership interests. So investors are reluctant to invest in LLCs because even if they didn’t receive a distribution, they need to pay tax on their profit portion.

Moreover, corporations make the ownership transfer easy by selling stocks, while the transfer of investment interest is challenging in LLCs.

How to Start a Corporation

Every state has its own laws regarding the formation of corporations in that specific state. However, the following DIY five steps are common in forming a corporation in any state.

If filing paperwork seems complicated or you want to focus on your business and want professionals to handle the corporation registration task, try ZenBusiness.com. They offer reliable and competitive prices for creating a corporation. 

  1. Select an appropriate name for your Corporation
  2. Nominate a Registered Agent
  3. Hold an Organizational Meeting
  4. File the Certificate of Incorporation with your state
  5. Get an EIN

The Day-to-Day Operations of a Corporation

The shareholders of a corporation generally get one vote per share. During the annual shareholders’ meeting, they elect a board of directors.

The selected board of directors hires and oversees the senior management responsible for running their corporation’s day-to-day activities.

The board of directors is responsible for executing the business plans of the corporation. It is essential to know that the board members are not personally liable for any debts incurred by their corporation. They do, however, have an obligation in care towards the corporation.

If board members neglect their duties, they may also face personal liabilities. Moreover, some tax statutes also provide for the personal liabilities of the board of directors.

Liquidating a Corporation

As you know, there are ups and downs in a business, and survival in such a competitive market is a huge challenge. Moreover, all business ties do not hold forever. So, like every other business, there is a chance that a corporation may terminate at some point.

Liquidation is a process through which a corporation’s legal existence can be ended. Corporation liquidation can be forced by the financial collapse of the corporation or maybe a voluntary decision to cease operations.

If a company fails to pay its bills, the creditors of that corporation usually trigger an involuntary liquidation. If the corporation cannot resolve this situation, the corporation files for bankruptcy.

Essentially, a corporation appoints a liquidator to sell the corporation’s assets. After that, the creditors are paid, and any remaining money is distributed to the shareholders.

Comparison with other Business Structures

If we compare corporation with other business structures such as LLC, sole proprietorship and partnership, corporation usually has higher liability protection, which means you are less likely to lose your personal assets in case the company is sued for something. Here, we’ll compare the bottom line of the other business structures.

Comparison with Sole Proprietorship

As a sole proprietor, you are liable for all business debts. If the company is sued, your personal assets including your house, car and bank savings can be seized.

However, in corporation, you are only liable for the amount of money you invested in the corporation.

Comparison with Partnerships

In a partnership, each individual is liable for the business debts. If the company is sued, your personal assets can be seized.

However, in corporation, you are only liable for the amount of money you invested in the corporation.

Comparison with LLC

As LLC, your personal assets are protected. LLC has lower liability protection than corporation. However, an LLC is more flexible than corporation. Corporations have more formalities than LLC.

The taxes are lower for LLC. However, it depends on your business structure and tax situation.

Comparison with C Corp

C Corp has higher liability protection than S Corp. As an S Corp, you receive pass-through taxation which means the company’s income and deductions are passed through to the individual tax return.

As C Corp, you receive double taxation which means the company’s income is taxed and then it is passed through to the individual tax return. However, you can lower your double taxation by paying yourself with stock options or distributions rather than wages.

Comparison with S Corp

S Corp has the same liability protection as C Corp. However, an S Corp is more flexible than a C Corp because there are fewer formalities.

As an S Corp, you receive pass-through taxation which means the company’s income and deductions are passed through to the individual tax return.

Comparison with B Corp

B Corp has higher liability protection than S Corp. B Corp is more flexible than C Corp and S Corp. All business of B Corp must be for public good and non-profit.

Comparison with Corporation Nonprofit

Nonprofit has the same liability protection as B Corp. Nonprofit is more flexible than C Corp, S Corp and B Corp because all business must be for the public good and non-profit.

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