Corporations

In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation's capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions.

The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. However, shareholders cannot deduct any loss of the corporation.

There are three types of corporations: subchapters S, C corporations, and limited liability companies. The major differences are centered around taxation, initial profitability, shareholder compensation, and deductibility of fringe benefit payments. After completion of the incorporation process, a corporation is automatically classified as a C corporation by the IRS. Board of Director approval is required, and a form 22 must be submitted to the IRS to change the status to subchapter S corporation. This action must occur within the first 75 days of incorporating the business. Use IRS form #2553.

A corporation is a legal entity that exists under the authority of state law and separate from the people who own, manage, and control its operations. Corporations acquire assets, incur debt, pay taxes, enter into contracts, sue/are sued, have perpetual existence, and issue shares of stock as evidence of ownership. To incorporate, articles of incorporation are filed with the Secretary of State’s office. These articles define the structure of the business (including its business purpose, amount of capital stock authorized, number of shares, and organization of a board of directors). The responsibility of the board of directors is to create by-laws and oversee major corporate policies and practices. An accountant and a lawyer versed in the legalities and organizational structure are recommended.

Advantages

1. Can provide a single business owner with limited liability
2. Separate legal entity (with rights and responsibilities of a legal “person”)
3. Limited liability for owners/shareholders
4. Transferability of ownership (i.e., shareholders may trade or sell stock)
5. Continuity of existence beyond original founders or shareholders
6. Absence of “mutual agency” (i.e., stockholders, acting as owners, may not enter the corporation into contracts or agreements)
7. Ability to raise large amounts of capital by issuing stock

Disadvantages

1. Cost related to setting up the corporation and filing the required forms with the Secretary of State’s office.
2. Formalities required by law (e.g., maintaining corporate minutes, having a board of directors, recording shareholder rights, maintaining corporate records and filings)
3. Considerable organizational costs
4. May take considerable time to set-up and organize a corporation
5. Greater amount of regulation and supervision by governmental agencies
6. Corporations are subject to real estate, personal property, and franchise taxes
7. C corporations are subject to double taxation (corporation and shareholder earnings taxed)
8. Subchapter S corporation requirements

• It must be a domestic corporation
• It must not have more than 75 shareholders (if stock is purchased jointly, a husband and wife are considered one shareholder)
• Citizens or resident aliens must own all stock
• It may have individuals, estates, or certain trusts as shareholders
• It must have only one class of stock
• It must have an election with all shareholders present

Advantages of Subchapter S Corporation

1. Limited liability
2. Avoids double taxation
3. Retains advantages of a corporation with respect to business obligation
4. Maintain status of corporation with assets and unlimited life separate from its owners
5. Owners can participate in management
6. No restrictions on the right to transfer ownership

Disadvantages of Subchapter S Corporations

1. 70 or fewer stockholders; only one class of stock
2. Stockholders limited to individuals, estates, or certain trusts
3. Must be a domestic organization and not a member of an affiliated group
4. Stockholders limited to citizens or resident aliens of the United States

If you are a corporation or an S corporation use the information in the charts below to help you determine some of the forms that you may be required to file.

Chart 1 - Corporation or S Corporation

Chart 2 - S Corporation Shareholders

Next:

• S Corporations
• Limited Liability Company (LLC) 

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