A corporation is a legal entity. That means it exists under law. There are strict requirements to form and dissolve it. In many ways starting a corporation is like creating a new person. A corporation can earn money, take out loans and be sued – just like a real person. This is a major benefit, because liability shifts from the shareholders to the corporation itself. The disadvantages are that corporations are more complex to set up and taxes are paid at the corporate rate.
Starting a Corporation
The formalities of starting a corporation are costly and take some time. Articles of incorporation must be drawn up and filed with the Secretary of State, along with the necessary fees. Bylaws have to be written and must follow certain guidelines. Officers have to be named and a board of directors has to be elected. These requirements are meant to keep ownership of the corporation separate from the corporation itself. Remember, under law, a corporation is a separate entity.
Authority for the daily operations comes from corporate officers instead of the owners – although these might be the same people. Officers are appointed by a board and the board is elected by the shareholders.
Recordkeeping requirements for corporations can be a burden. Regular meetings of the directors have to occur (and must be recorded), as well as financial records that show corporate activity is separate from personal dealings.
One important step is to investigate the corporate name. Every corporation in a State must have a distinct name. A name search should be done early in the process.
The C in C Corp refers to a sub-chapter of the Internal Revenue Code – the rules the IRS uses to determine tax rates. The corporate tax rate is a political football. It goes up and down based on federal legislation. For the 2009 tax year, the rate ranges from 15% (profits under $50,000) to a high of 35%.
In some cases, profits are double taxed – once as corporate profits and once as personal income for those who receive the profits (as dividends on shares). This doesn’t happen when the owners of the corporation are also drawing a salary, because salaries are deducted before corporate profits are calculated.
Note that the corporate State tax rate varies considerably from State to State. This is why it may be better to incorporate in one State instead of another – sometimes even when the business is located elsewhere.
All of the paperwork and recordkeeping are designed to keep the corporation separate from the stockholders. This separation is true for liability also. Sometimes referred to as the corporate shield, stockholders are protected from lawsuit when the corporation is sued. The assets of the corporation are all that can be collected against. This shields the owners from personal loss.
Corporation Credit and Financing
The ability to attract investors by issuing stock is a great advantage. Capitalization is freed from loans based on assets alone. Often, stock prices are driven by potential instead of actual profits or inventory. Of course, this comes with an important consideration – stockholders have rights and are the true owners of the company. This can lead to takeovers or loss of control of a corporation when stock is purchased that gives a majority interest.
A corporation can be more difficult to sell as well. Unlike the simple transfer that occurs with the sale of a sole proprietorship, a corporate sale will involve a formal evaluation of assets and a vote of the board of directors. The formalities are designed to protect the interests of the stockholders.
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