123s of Corporations
The corporation is one of the oldest types of business models and is likely the most common entity type that comes to mind when thinking of a business. The concept of a corporation was first developed under Roman law and adopted by England in the early 17th century as a distinct legal entity.
Corporations became commonplace in the United States at the turn of the 19th century during the Industrial Revolution. Investors and owners increasingly were drawn to the corporation as an efficient means by which to operate a large enterprise while offering liability protection to the shareholders. Today, the corporation is a mainstay for domestic and international business.
Like most legal entities, one of the main advantages of forming a corporation is that the owners and their personal assets are protected from creditors of the corporation, which is known as the “corporate veil.” Except in rare situations, the owners typically stand to lose only the money invested in the corporation. Accordingly, only the corporation’s assets need be used to pay business debts and obligations.
There are certain circumstances in which an owner of a corporation can be held personally liable for the obligations of the corporation. The owner, for example, may be personally liable if she failed to withhold or otherwise remit taxes withheld from employees’ wages, or treated the corporation as an extension of her personal affairs, rather than as a separate legal entity. In such circumstances the third party would be allowed to “pierce the corporate veil” and hold the shareholders personally liable for the corporation’s acts. Although “piercing the corporate veil” is not commonplace, an owner should never commingle personal assets with business assets.
Formation and Governance
Similar to other entities, filing a certificate of formation or articles of incorporation with the state government, typically the secretary of state’s office, is required to form a corporation. Depending on the size and complexity of the corporation, however, this filing may be much more complex than with other entities (such as a limited liability company or limited partnership).
Governance of a corporation is typically established through a combination of the certificate of formation, bylaws, and possibly a shareholders’ agreement. The bylaws establish the basic rules that govern the ongoing formalities and decisions of corporate life. This usually includes the requirements for regular and special meetings of directors and shareholders, the quorum needed for such meetings, the number of votes that are required to approve corporate decisions, and other governing decisions. A shareholders’ agreement may supplement the bylaws on how the corporation should be operated and provide special shareholders’ rights and obligations. The agreement may include information on the management of the corporation and privileges and protection of shareholders or special rights for certain classes of shareholders. For example, these rights could include voting provisions for the election of directors, restrictions and rights of first refusal on shares transfers, preemptive rights, as well as tag-along and drag-along rights.
Corporate Income Tax
One of the primary drawbacks of a corporation is the notion of possible “double taxation.” Unlike a partnership and other pass-through tax structures, such as the “S corporation,” the corporation itself must pay tax on income before profits are distributed to the owners.
Historically, rates were much higher ranging from 15% to 35%, but this recently changed to 21% under the Tax Cuts and Job Act. While the shareholders can elect for a corporation to be taxed under Subchapter S of the Internal Revenue Code (an S-corporation), there are substantial restrictions on ownership and share structure, typically reserving the S-corporation for small businesses only.
Types of Corporations
While the distinction between an S-corporation and C-corporation is merely tax election and not a state-level structural difference, there are a few other types of corporations. General business corporations are usually reserved for larger enterprises. Close corporations, however, are often used for smaller enterprises in which all or most of the shareholders are actively involved in the management of the business. Most states typically allow close corporations more flexibility in management. Professional corporations are another type, but these are limited to licensed professionals as their name would suggest and only professionals licensed in the corporation’s field may be shareholders.
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