A corporation is a separate legal entity from the employees, managers and/or owners of the corporation. Establishing a corporation is more complicated than setting up a sole proprietorship and a partnership. A corporation is formed by filing a corporate charter known as Articles or Certificate of Incorporation and paying a fee to the Secretary of State. (The corporate charter specifies the name of the company, its purpose and the number of authorized shares.) The name of any corporation should include some indication that it is a corporation such is "Incorporated" or "Corporation" or a similar abbreviation.
Bylaws, which outline basic rules of operation, are also required and can be quickly drafted by a corporate attorney. They define the basic structure and operation of the company. You will need to provide a copy of your bylaws to open a bank account and do other types of business transactions.
Ownership is conveyed through the issuance of stock. Stock can be owned by one or as many as several thousand shareholders. Technically, the shareholders control the corporation. However, in most cases, shareholder consent is only required on decisions regarding sale or dissolution of the company, election of directors for the board or amending the corporate charter. Shareholder meetings must be held at least annually. Written notice of the meetings must be provided well in advance.
In most states, one person can form a corporation. It is important to ensure that you operate consistent with the practices of a corporation (having bylaws and annual shareholder meetings). Failure to do so may allow someone to 'pierce the corporate veil' and sue you personally. Consult a tax advisor and/or attorney to see if a corporation is an appropriate structure for you.
The Board of Directors is elected by the shareholders and meets periodically to focus on long-term strategic issues. The Board generally delegates specific day-to-day decision-making authority to the officers or management team.
Corporations can be set up in any state independent of where your primary place of business is. States have different tax and filing provisions that may make formation in one state more advantageous than another. However, there may be additional costs to form a corporation outside the state of your home state and you may still end up having a tax liability within your home state, so you should consult an attorney or financial advisor before deciding to do establish your corporation away from home.
Shareholders own only the stock, not the assets of the corporation. Also, all corporate debts and liabilities of the corporation remain the corporation's. The owners and employees are shielded from most personal liability resulting from the activities of the corporation. The existence of this shield assumes that you are consistently operating with the formality of a corporation as noted above and not do anything 'outside the scope of the corporation'. If you personally do something illegal, the corporate shield will not protect you.
If the corporation fails, the owners lose their investment and the employees may lose their jobs, but none of their personal assets will be attached to satisfy the debts or liabilities of the corporation. In certain instances, however, creditors may be able to hold owners personally liable. The instances include: owners not adequately capitalizing (or investing funds) in the company at the outset, not indicating the existence of a corporation by the use of "Inc." or "Corp" in the name of the business on stationary or business cards, or incurring a liability while doing business before the corporation is formally set up.
A corporation files a tax return and pays tax on any profits it earns. Each shareholder pays tax on income from dividends or profit upon sale of stock. This double taxation can be a deterrent establishing a corporation for some business owners. This is rarely significant concern for a small business though because there are several things you can do to offset this. First, you will pay yourself and other service-rendering employees a tax-deductible salary. Additionally, the corporation can own assets and therefore can purchase equipment and health insurance and other items required for the business and deduct the expense of those purchases (or depreciation expense of certain capital equipment) further reducing the tax liability for your company. Finally, the corporation is likely to be taxed at a lower aggregate tax rate than most individual rates. Further, it is unlikely that, in the early stages, you will be paying dividends to any of the shareholders.
Since corporations are separate entities, their existence is independent of the lives of the shareholders, managers and employees. Shares can generally be easily transferred from one person to another or to another corporation. Corporations enjoy what is called "perpetual life".
A sub chapter S corporation is a particular type of corporation and is named for the Internal Revenue Code that governs it. It operates like a regular corporation providing limited liability to all owners except that it is taxed like a partnership.
There are a few restrictions on S Corps:
It must file an IRS S Corporation Tax Election form (Form 2553) with the IRS. All revenue and expenses (profits or losses) flow through to the owners and are reported on their individual 1040s according to their percentage stock ownership. Profits are reported even if those profits are reinvested in the business and are not actually distributed to the owners. Unlike a limited partnership, the amount of loss an investor can use to shelter income is limited to the amount invested. Debts of the S Corp cannot be passed along to the shareholders like they can be in a limited partnership.
Another advantage over a partnership is that in an S corporation, non-employee shareholders may be paid dividends without the worry of double taxation because an S Corp does not pay corporate tax. If you are expecting to show losses in the short term, those losses can be passed through to your individual tax return. Once you start showing a profit, this election can be undone.
| Corporation | California | Illinois | Massachusetts |
| Initial State Filing Fees | $100 | $75 + $25 franchise fee | $200 min; $300 foreign |
| Min State Fees/Tax | Min $800 | $25 + franchise tax due | $85 |
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