Corporations and the Law
If you are planning to go into business, chances are that you will decide to form a corporation. Below are both the pros and cons of choosing this legal structure for your business.
- Protect Owner(s) from Legal Liability -- Incorporating one's business makes the business a separate legal entity and provides its owner with a layer of protection separating the liabilities of the business from the individuals with an ownership interest. This applies to both the debts incurred by the business and also its activities. To maintain this protection, legally mandated corporate formalities must be followed.
- Structure of Power -- There is a management hierarchy to a corporate business comprised of directors, officers and shareholders. Each have clearly defined responsibilities and roles within the corporate structure.
- The Ability to Attract Investors -- Once formed, a corporation can issue stock, making this an attractive selling point to potential investors looking for investment opportunities in various business ventures.
- Stock and Employee Stock Options -- While this mostly applies to larger corporations, having stock benefits and options that an employee is legally allowed to purchase at a price that is locked-in is an appealing perk for prospective employees.
- Required Corporate Formalities -- By law, corporations must observe certain formalities to maintain the corporation as a disparate entity apart from its owners. Some of these formalities include keeping strict records of the corporation's activities, upholding the financial independence of the corporation and holding routine meetings of the directors.
- Time and Expense of Incorporation Procedure -- There are numerous documents like the corporate bylaws and articles of incorporation which must be drawn up (usually by an attorney). Additionally, filing fees are required to be paid to the Secretary of State's office or other filing agency in the state where the business is incorporated.
- Possible Tax Liabilities -- Once a business is incorporated, there is the potential for it to be taxed twice; once for the profits that are earned and again for individual stockholders earning paid dividends from the corporation. While primarily a concern for larger businesses, this problem of double-taxation can be alleviated by choosing an "S-corp" tax status.
Types of Corporations
There are different types of corporations in the business world. The goal for entrepreneurs is to choose the option that best fits the needs of the business. Below are some options to consider.
- S Corp (or Sub S Corp) -- This type of corporation taxes the profits at a personal income tax level. While S Corps are required to file annual tax returns, no taxes are paid because the individual shareholders pay the taxes on their share of the corporate income on their own personal tax returns. For purposes of benefits and employment, the owner-employees are considered to be partners.
- C Corp -- These businesses maintain completely separate identities from their owners. They are alternatively called "ordinary corporations" and owners are not proprietors or partners but shareholders. C corps are legally able to make business deals, own property and sue other businesses.
- Not-for-Profit Corporation -- Sometimes referred to as 501(c) corporations due to the section of the Internal Revenue Code designated for non-profit organizations, these types of corporations are formed specifically for purposes besides the operation of a profit-seeking business. Some qualify for state and federal tax-exempt status.
- Professional Corporation -- These are created to permit shareholders who are all members of the same profession (attorneys, doctors, accountants, engineers, etc.) to form corporations that allow them to share profits and management responsibilities, yet limit their vulnerability to the others' malpractice actions or professional negligence.
Business professionals and entrepreneurs who are interested in learning more about corporations and the law should seek the counsel of a business law attorney to cover all of their legal bases.