Forming a Corporation-What is a Corporation Anyway?
Overview
Corporations are creatures of historic common law deriving their name from the Latin word "corpus" meaning "body." Formalistically, a corporation is an artificial person or legal entity created under the authority of the laws of a state or country. So that the corporation is considered a body distinct from those of the individuals who own and manage it. In other words, the law treats the corporation as a person separate and distinct from its owners and so it can sue or be sued. So the corporation can be liable for its actions without necessarily making the owners liable too. Thus, simply stated, the corporation can in most cases shield its owners from the actions taken by the corporation.
Further, because a corporation is considered a separate person, its income is taxed like anyone else's would be (of course at a separate rate set for corporations as opposed to individuals).
Forming a corporation and operating a business through it generally shields owners and investors from legal liability for the company's acts and limiting their potential losses to the amount they invested in the company. Similarly, a corporation makes its own income, which is then taxed before it is distributed to investors as dividends. Corporations also have certain formalities: shares of stock, each class of which can have its own characteristics; officers and boards of directors elected by shareholders; and formalized meeting and voting procedures that protect both the company and the individual shareholders.
Because of this fact, corporations have a certain credibility that partnerships and Limited Liability Companies (LLCs) do not. Potential investors, lenders, business partners, and even overseeing legal authorities will very likely have slightly more respect for a corporation, because it is a historic creature of business with procedures most people know and understand from their earliest years.
In recent years, legislatures have carved-out a few newer forms of the older corporate model, but to understand corporations generally it's important to know their general elements.
Formation-Types of Management
To form a corporation, you have to have the Articles of Incorporation filed with the state in which you want your corporation to be domiciled (where its formal headquarters will be). The decision about which state to file in is an important one because it effects where the corporation can be brought into court, what laws will affect it most, the taxes it will pay, and its image amongst potential customers.
For small and medium-sized businesses it may make sense to create the corporation in the state in which you are located and where the corporation will do most or all of its business. This is more convenient, all the parties involved with the company are likely to be there, and you are likely most familiar with your state's government and laws. Larger companies, though, may want to incorporate in another state, perhaps like Delaware or New York, where there is a large amount of case law, and where many judges are experienced in the intricacies of business law, making the legal risks of their business more predictable. Still other companies may wish to incorporate in states with greater financial privacy, or even offshore in another country. It is possible to file in one state but do business entirely in another, and doing so requires another filing establishing the company as a "foreign company" (from another U.S. state) doing business in the new state with a registered agent in the new state as well. Registered agents are the people to whom legal papers, including service of law suits, will be given and all states require one to do business in their state. Wherever you decide to incorporate it is good to be familiar with that state's particular requirements to make certain that they match your needs.
The filings and documents involved in forming a corporation are numerous. The initial Articles of Incorporation generally have to include the corporation's name and address (principal place of business), its purpose (usually kept broad), the name and address of its registered agent, and stock information. Further, each corporation will have Bylaws laying out the number of directors and corporate officers, the amount and types of stock the corporation is authorized to issue, the procedures for director and shareholder meetings, record-keeping procedures and rules, and the like. State law may dictate much of this if the incorporators don't specify how they want these decisions made so it's best to decide which of these issues are most important to you before looking to incorporate your potential company.
Generally speaking, corporations can have other corporations or trusts or partnerships as shareholders. However, there are limits on the types of owners where the corporation is an S Corporation, Professional Corporation or Non-profit Corporation (all discussed more on this site).
Naturally, it should be decided as soon as possible who will actively manage the company and as what officer or director, as described in the corporate Bylaws.
Liability, Taxes and Other Pros and Cons
The primary reason to form a corporation is to limit liability. If a few investors contributed funds together, bought a storefront, and started doing business they would be legally liable (i.e. could be sued) for their own acts, the business's acts, and possibly their co-investors acts as well. Sued not only for what they put into the business, but what they have in their personal and family assets. Corporations are a way of generally limiting that liability to the amount the owners have invested. If a corporation is truly a mere shell of some individual that really does no business of its own, sometimes plaintiffs can "pierce the corporate veil" and tag an owner with liability for what the corporation did. However, if the corporation is legitimate and does its own business in the proper way while observing the corporate formalities, then owners are generally shielded from personal liability.
As mentioned above, a traditional corporation's income is taxed. Historically, this was the cost of creating a separate entity to do business of its own. The profits it makes are taxed, and then those profits are distributed by the corporation to its owners (typically as dividends). At that point, the income to the owner is taxed again. This is the double taxation of corporations that has long been disfavored by investors.
In response to this, a person forming a corporation can elect to have their company be considered an S Corporation under the Internal Revenue Code (the "S" referring to a code section dealing with these kinds of companies). If the corporation meets certain restrictions (such as the owners must typically be individual residents, not foreign nationals or other entities), and is granted S-corporation status, the income of the corporation can flow right through to the shareholders' individual tax returns, and not be taxed at the corporate level. That makes S-corporations similar to limited liability companies ("LLC") and partnerships in this respect. Likewise, non-profit corporations have their own rules regarding corporate income, and professional corporations do not protect the professional shareholders from the malpractice or negligence of their actions. Modern laws have evolved to create these other types of companies, but traditional corporations, or C-corporations still exist and prosper to this day.
Corporations also benefit from a fairly straightforward way to assign (sell) interests in ownership-simply sell the stock in whatever amount. If it is publicly traded, this can be as easy as going to an online broker. If the stock is privately held, it may be less liquid but it is still easy to transfer when and if an agreeable buyer and seller can be found.
Another, less tangible, benefit of having a corporation, as opposed to a partnership or LLC, is the trust and respect the idea of a corporation has in society. As mentioned above, potential investors, lenders, customers, business partners, and even courts may give more respect to a corporation than they might a more temporary-seeming partnership or LLC.
Duration & Dissolution
Where other forms of businesses may be formed with specific duration or lifespan, corporations are most often created to be of perpetual duration.
Corporations can be bought by purchasing all of their stock, they can be dissolved with the filing of Article of Dissolution, they can go bankrupt, and in certain cases courts can order their dissolution. But, consistent with the idea of a corporation as a separate legal entity, they are less likely to be dissolved or simply expire than other types of businesses, and can in many cases live lives much longer than their original founders.
Conclusion
A corporation is a separate person than those who created it and those who run it. From this basic fact most of its other characteristics flow naturally: it is generally responsible for its own actions, its income is taxed, its officers, directors, and shareholders are protected by layers of law formalizing meeting and voting procedures so that no one person uses it as its own personal company.
While these facts generally mean a corporation's profits are taxed twice, and it means that the formalities of doing business will always be more detailed than some other forms of business, corporations have their advantages. They separate types of liability from ownership, have a historical interaction with and respect of society, the ability to live long past their original creators, an easy mechanism for assigning ownership (stock), the comfort and protections that formal procedures ensure, and in more modern forms (S Corporations, Professional Corporations, and Non-profit Corporations) flexibility to benefit many different types of businesses. When choosing a business entity, a corporation is always the first thing to consider and, for many, it will be exactly what fits their needs.
No matter the corporate type, Elite Incorporation is ready to form your company and make your vision reality.