Business Organization - Corporation

A corporation has a legal and tax identity separate from its owners, who are called shareholders. Your state's law may require that a corporation be chartered by the state and that articles of incorporation be filed with the Secretary of State. The articles of incorporation should include the name of the corporation, purpose of the corporation, names and addresses of incorporators, location of the registered office, name of registered agent, duration of the corporation, amount and kinds of capital stock that may be issued at the beginning, and description of the voting rights of shareholders. Articles of incorporation and by-laws should be prepared by legal counsel who is familiar with your state's corporate law.

Once formed, your state's law may require that a corporation file an annual report with the Secretary of State. It should list names and addresses of directors and officers and the number of shares issued. In addition, annual meetings of directors and shareholders must be held with written minutes reflecting important transactions or decisions. Corporations must file federal and state tax returns. 

The primary advantage of the corporation is its "limited liability." While the corporation is fully liable for all its business obligations, individual shareholders are liable only to the extent of their investment. In practice, however, owners of small, closely held corporations (family members, for example) are often required to personally guarantee the debts of their corporation. 

While the corporation offers shareholders some protection from liability claims, it is not a substitute for a comprehensive business and personal liability insurance program. 

For income tax purposes, business owners must choose whether the corporation is a C or an S corporation. C corporations pay taxes on income. Shareholders do not report any portion of corporate income or losses on their individual returns, but when income is passed on to the shareholders as salary or dividends, it is taxable income for them. 

C corporations are eligible for a wide variety of retirement and benefit plans, as well as these fringe benefits: $50,000 group term life insurance; disability insurance and medical expense reimbursement plans; certain types of deferred compensation plans and employee stock ownership plans. 

A corporation with 75 or fewer employees may make a special election to be taxed as an S corporation. Though an S corporation must file a federal income tax return (Form 1120S), income is allocated to the shareholders and is taxed at their personal state and federal rates, similar to a partnership. An S election must be filed with the IRS on or before the 15th day of the third month of the first taxable year. 

An S corporation is eligible for a wide variety of retirement plans and benefit plans. Shareholders who own two percent or less of stock also are entitled to the fringe benefits available to C corporation employees. The shareholders of an S or C corporation elect a board of directors that is responsible for the overall direction and management of the corporation. Directors elect officers who are responsible for day-to-day operations. A shareholder can be a director and officer. 

A corporation facilitates estate planning, as it is easier for an owner to give or bequeath shares of corporate stock to heirs than it is to give or bequeath title to equipment, buildings or an interest in land. However, it is usually difficult to liquidate a C corporation or, usually to a lesser degree, an S corporation without adverse tax consequences.