If you are considering forming a business, you have likely heard about options to have your business established as a corporation. While many individuals refer to “corporations” as a broad category of business formation, what they are really talking about is the creation of a “C corporation,” which is a traditional corporation business model that is differentiated from an S corporation or a closed corporation.
Corporations are business entities that are created in order to limit the personal liability of business owners. Corporations are created as independent entities with their own legal and tax status, which separate the business and its liabilities from the original owner. One of the advantages of this separation is that a creditor of a corporation, or an individual filing a lawsuit against a corporation, typically cannot go after the personal assets of the business owners in order to satisfy any debts or judgments against the corporation. Thus, individuals are protected by the corporation’s status.
Although the creation of a corporation protects an owner from liability in many circumstances, it does not prevent liability in all circumstances. Owners can be held liable when they engage in conduct that is intentionally illegal or fraudulent, or when they personally act in a way that causes harm to others. Owners can also be held liable when they fail to respect the separation status of the corporation. Thus, for instance, if an owner treats a corporation as his or her private bank, frequently drawing money out of the business or otherwise mingling personal affairs with the corporation’s affairs, the owner can be held liable. This can also occur when an owner fails to follow proper procedures for managing a corporation, such as providing adequate notice to shareholders. This is often known as “piercing the corporate veil,” since the owner does not respect the veil of separation between the corporation and the individual.
Individuals wishing to form a corporation must follow certain specific steps in order to do so. These steps are typically set forth by the laws of the state where the business will be “incorporated.” In most states, the owners of a business must file articles of incorporation, which set forth basic facts about the corporation, including its name, place of business, and contact information for owners or directors. In addition, corporate bylaws must also be established. Corporate bylaws are the rules and procedures that govern the administration of the corporation, such as how officers and directors will be elected, when meetings will be held, and how profits will be divided. Finally, stock certificates must be issued to any shareholders of the corporation, who are typically the initial owners. The certificates indicate the percentage of ownership that each individual has in the corporation.
Once a corporation is formally created, the corporation and its owners have ongoing obligations that must be fulfilled in order to retain corporation status. These include holding annual meetings for shareholders and officers, maintaining detailed financial and operations records, filing financial documents, and filing separate tax returns for the corporation.
C corporations must file corporate tax records reporting their yearly profits and expenses. When a C corporation receives profits for the year, it must also pay corporate taxes on those profits. If the corporation passes on those profits, in the form of dividends, to its shareholders, these dividends are taxed twice. The corporation must pay taxes on them, and the shareholder must also report them. However, if an owner works for the corporation and receives payment in the form of a salary or bonus, these amounts are subject to taxation from the owner, but not the corporation.
