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Business Types: Corporations

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What is a corporation?

A corporation is a legal entity, separate from the owners and shareholders, created for profit. Corporations can be publicly held or closely held. A publicly held corporation is usually an organization which: has a vast number of shareholders; its shares are typically sold on an outside market, e.g., the New York Stock Exchange; most shareholders do not participate in the general management or operation of the business; and there is generally a free transferability of corporate shares. A closely held corporation, on the other hand, is typically one which: the number of shareholders is small; there is no outside market for its shares; all or most of the principal shareholders participate in its management; and the free transferability of shares is restricted by agreement.

A corporation is created by filing the proper documents with the Secretary of the State and paying a filing fee. It is important to note that a corporation's affairs are governed by the law of the state they incorporate in even if the corporation has little or no other contact with the state. Corporate formation is statute specific, therefore it is important to look at the state statutes for where the corporation is to be incorporated. When selecting a state to incorporate in it is important to consider the following: a dollar and cents analysis of the relative cost of incorporating, or qualifying as a foreign corporation under the statutes of the state under consideration; and consideration of the advantages and disadvantages of the substantive corporation law of such states. As a practical matter, the choice often comes down to the jurisdiction where the business is to be conducted, or Delaware, the most popular outside jurisdiction. If the corporation is closely held and its business is to be conducted largely or entirely within a single state, local incorporation is almost always preferred.

The process of incorporation in most states is relatively simple. The Articles of Incorporation must be filed with the Secretary of State and at such time the date of existence of the corporation begins. The Articles of Incorporation generally must set forth: the corporate name, which must contain words such as "corporation, incorporated, company, limited, etc." or the abbreviations of such words at the end; the number of shares the corporation is authorized to issue; the street address of the corporation's initial registered office and the name of its initial registered agent; and the name and address of each incorporator.

After the Articles of Incorporation are filed, the corporation should also: prepare the corporate bylaws; prepare notice calling a meeting of the initial board of directors, obtain a corporate seal and minute book for the corporation, obtain blank certificates for the shares of stock, arrange for their printing or typing and ensure that they are properly issued; open a corporate bank account; prepare employment contracts, voting trusts, shareholder agreements, share transfer restrictions, and other special arrangements; obtain taxpayer identification numbers, occupancy certificates and other governmental permits; and evaluate whether the corporation should file an S corporation election for tax purposes.

Corporations are taxed as entities such that a corporation's income is taxed to the corporation and not to the shareholders. A C corporation is a separate taxpayer that must pay taxes on its income according to a Tax Rate schedule set forth in the Internal Revenue Code, which is different from the schedules applicable to individuals. A corporation that has not elected to be an S corporation, is automatically a C corporation. The S corporation election, however, is only available to corporations with fewer than 75 shareholders. Therefore large publicly held corporations have no choice but to be C corporations, while many closely held corporations can elect to be an S corporation. However, a closely held corporation having the ability to elect to be an S corporation can chose to be a C corporation.

A C corporation is first taxed directly on its income, which is calculated using the corporate rate schedule. Then if the corporation makes distributions to its shareholders, the amount of those distributions is subject to a second tax at the shareholder level to the extent the corporation has earnings and profits. The alternative to the C corporation tax treatment is the S corporation election. The effect of this election is that the corporation has many of the tax characteristics of a conduit entity, with corporate income or loss being directly allocated to the shareholders. The election of an S corporation can be made by filing a relatively simple form and as stated above is only available in limited circumstances. Other limitations for the S corporation election are: the corporation must have no more than 75 shareholders; the shareholders must be individuals, i.e., natural persons; no shareholder may be a nonresident alien; and the corporation must have only one class of stock.