Perhaps the most important decision you'll make when starting your business is what type of business entity you will choose. The most common business entities are a sole proprietorship, partnership, limited liability company, and corporation. In the last part of this series, we will discuss the pros and cons of the corporation.
A corporation is a distinct legal entity, both for legal and tax purposes. It is deemed to have an existence separate and apart from its owners, the shareholders. A corporation has all of the powers and rights of a natural person, including the right to own property, to sue and be sued, and to enter into binding contracts.
Although owned by its shareholders, a corporation is controlled by the board of directors, which is elected by the shareholders. The shareholders' participation in the management of the corporation is essentially limited to electing the directors and voting on certain major corporate actions. However, shareholders may elect themselves to the board of directors and may still participate in management.
While the directors control and are permitted to manage the corporation, the board of directors generally appoints officers to manage the corporation's day-to-day operations. In smaller corporations, such as S corporations, the shareholders are often also the directors and officers.
- The corporation enjoys a separate legal existence with its own rights, privileges. and liabilities apart from the shareholders.
- The shareholders' liability is limited to the amount they paid for their shares in the corporation.
- Directors and officers are normally insulated from personal liability for the debts and obligations of the corporation.
- Additional investment are generally easier to obtain, i.e., corporations may obtain investments from third party sources in exchange for the sale of stock.
- Corporate formalities must be observed such as annual shareholder meetings and regular director meetings, among other formalities.
- Increased cost to form and operate a corporation, i.e., file articles, draft bylaws, shareholder agreements, file annual reports, etc.
- Potentially decreased personal control of the business because of the separate roles of shareholders, directors, and officers.
- The profits and losses of a C corporation are subject to double taxation: once at the corporate level when earned; and then at the shareholder level when distributed (does not apply to S corporations).
For legal purposes, an S corporation is no different than any other corporation. However, an S Corporation enjoys certain tax benefits. For instance, an S corporation is considered a pass-through entity, similar to partnerships. In this manner, the S corporation escapes the double taxation on dividend distributions of a C corporation, and the shareholders are allowed to offset losses sustained by the S corporation against their other income.
Not all corporations may become S corporations. The corporation must have no more than 100 shareholders, must have only one class of stock, and shareholders cannot be a corporation, LLC, or partnership, among other restrictions.
A corporation is a good choice for business owners that are seeking to minimize their personal liability, do not mind the increased formalities and operating costs of a corporation, and are seeking outside investors. While the double taxation of income of a C corporations is a downside, most new corporations can quality as an S corporation to avoid this.
If you have any questions regarding your new business, or would like assistance forming your corporation, schedule a free consultation with J.Cutler Law.