What is a Corporation?
A corporation is a business entity that is owned by its shareholder(s), who elect a board of directors to oversee the organization’s activities. The corporation is liable for the actions and finances of the business – the shareholders are not. Corporations can be for-profit, as businesses are, or not-for-profit, as charitable organizations typically are.
Types of Corporations
There are two major types of corporations as well: Subchapter C corporations, which are larger organizations owned by multiple shareholders, which can also be other businesses, and Subchapter S corporations, which are often (but not always) smaller businesses owned by an individual shareholder.
Before creating a corporation, consider what you hope to gain from establishing this separate entity. The biggest advantages of having a corporation are:
- As with some other types of businesses, corporations provide liability protection for its owners, who are called shareholders.
- Companies hoping to raise money from investors will have an easier time as a corporation, which can sell ownership shares.
- Corporate profits are taxed, but at a lower rate than the personal income tax rate individuals pay.
- Potential employees may find working for a corporation, with the prospect of ownership benefits, to be more appealing than working for a privately-held company.
- The corporation can offer a medical reimbursement plan, deducting the cost of providing insurance to employees while allowing employees to use the benefit tax-free.
While corporations can certainly shield owners from liability, the downsides are sizeable and very costly:
- C Corporations are complex and expensive to set up.
- Once established, corporations spend significant sums of money to stay on top of changing business regulations and timely filing of paperwork. They are best for large organizations with many employees.
- Corporations pay federal, state, and sometimes local taxes on profits, unlike LLCs.
- The corporation pays taxes on dividends paid to shareholders, who then pay taxes on that income themselves.
Forming a Corporation
Corporations are often formed in the state in which the business operates, but it doesn’t have to be. Some corporations are formed in states thought to be pro-business, such as Delaware or Nevada, although that creates extra paperwork. You then need to register the corporation as a foreign entity in the state in which you are doing business, and pay taxes to that state.
The next step is creating Articles of Incorporation, which are filed with the state in which you have registered the corporation. These include:
- The name and physical address of the business.
- A description of the business and its goods and services.
- The name and address of the registered agent, or the person authorized to receive official notices.
- A count of the number of shares issued and to whom.
And then create by-laws, which are the rules of the corporation. They include, at a minimum:
- How often the board of directors meets, and when.
- Whether the business operates on a calendar or fiscal year.
- How long board members can serve.
- Rules for changing by-laws.
By-laws can be amended as needed once the corporation is formed.
If you expect at some point in the near future to take your company public through an initial public offering (IPO), a C corporation may make a lot of sense.