Business corporations are created when the Secretary of State approves articles of incorporation prepared by incorporators. Corporations formed for profit have to have shareholders, directors and officers. The shareholders are responsible for electing the board of directors. The board of directors are ultimately responsible for the management of the business, but they employ or elect officers who run the day-to-day operations. Corporations may range in size from an incorporated one-person business to a large multinational business. A corporation is a separate legal entity (a legal person) and can own property, make contracts, bring lawsuits, and be sued as a person.
- The shareholder’s risk of loss from the business is limited to the amount of capital that the shareholder invested in the business.
- A corporation can raise capital by issuing stock which can allow the corporation to expand.
- A corporation is required to pay corporate income taxes. Shareholders who receive dividends from the corporation are required to pay personal taxes on these dividends. This results in double taxation which may certainly be a disadvantage against incorporation of small businesses with just a few shareholders (e.g., close corporations). One way around double taxation in a close corporation situation where the shareholders also work for the corporation, is to make sure that they receive salaries and bonuses sufficient to wipe out any profits that would have to be distributed as dividends. However, any salary and bonus paid cannot be more than what would be reasonable considering the type of business the corporation is involved in. If the salary is unreasonable, the IRS may declare that part of the salary is really a dividend, and tax the corporation on this portion as well as the individual.
- The organization and operation of a corporation does involve some expenses which would not be required in a sole proprietorship. For example, certain filing fees have to be paid upon filing the articles of incorporation.
- State corporation laws may also require the filing of an annual report, as well as other reports
An S corporation combines the limited liability of a corporation and the “pass-through” tax-treatment of a partnership. It is a business structure suited to small business owners who want the continuity and liability protection of a corporation but wish to be taxed as a sole proprietorship or partnership. An S corporation is essentially a corporation that has elected to become an S corporation for tax treatment purposes. The S corporation election form 2553 is filed with the Internal Revenue Service. Instead of being taxed at the corporate level, the income “passes through” to the individual shareholders. This is the same basic “pass-through” treatment afforded partnerships and limited liability companies. Any income or loss generated by the S corporation is reported on the individual tax returns of the shareholders, rather than being taxed at the corporate level. Thus, the S corporation election is a popular choice for many small businesses.
A close corporation is one in which, as a general rule, all or most of the shareholders are actively involved in managing the business. Most corporations could qualify as a close corporation. Approximately 90 percent of all businesses in the United States are closely held. These firms differ from most publicly traded firms, in which ownership is widely disbursed and the firm is administered by “professional” chief executive officers.
Many closely held firms are also family businesses. Family businesses may be defined as those companies where the link between the family and the business has a mutual influence on company policy and on the interests and objectives of the family.
Buy/sell agreements, also known as shareholder agreements, should be considered by all close corporations. A buy-sell agreement is an agreement between the owners of the business for purchase of each others interest in the business. Such an agreement will spell out the terms governing sale of company stock to an outsider and thus protect control of the company. It can be triggered in the event of the owner’s death, disability, retirement, withdrawal from the business or other events. Life insurance owned by the corporation is often used to provide the funds to purchase the shares of a closely held company if one of the owners dies.
The prolonged disability of an owner/shareholder can also present serious difficulties for closely held firms. A long-term disability buy/sell agreement can provide a cushion to protect the disabled principal’s interests during recovery. The first step in implementing such an agreement is to determine how long the company should be without the disabled partner’s services before a buyout is activated. Some attorneys recommend that an actual buyout of ownership interest be postponed at least 12 months but not more than 24 months after the infirmity occurs.