Formation, LLC, Corps Why to Incorporate and Managing Taxes & Formalities

What is a corporation and why do people choose to file them instead of a partnership or a simple sole proprietorship? This article will give you a basic primer on corporations and understand what they are, why they are desirable and what is required to incorporate your business.

What is a corporation?

A corporation is group of persons who want to collaborate for a business proposition and require a singly entity to to run the business. A formed corporation is a "legal person" - it is its own entity and separate from the people who created the corporation, including the people who manage and control the corporation. Just like regular people, a corporation is an entity that is bound by law to the contracts that it makes. Also just like any regular person, a corporation is liable for taxes and debts. Even if the owners or "shareholders" of a corporation die, the corporation will continue to exist after their death.

Why do people choose to create a corporation for their business

There are many reasons why a group of people will choose to form a corporation instead of a partnership. Some of the reasons we will discuss below include the the owners not being legally responsible for the debts of the corporation of which they may own shares. People may also want to raise money for corporate activities and wish to sell shares of the business to investors and the corporate form provides for such instances, including options to give employees incentive to peform.

How is personal liability different with corporations than partnerships or sole proprietorships?

One of the most significant benefits of operationg a business as a corporation is that owners have limited liability with regard to debts and obligations of the corporation. If a lawsuit is filed against the corporation, the shareholder's personal assets are not at risk, only those of the corporation. Frequently small businesses form corporation entities to shield their personal property from creditors such as cars, boats, homes and other property that could be seized in a lawsuit. In return for this limited liability, certain formalities must be followed and the corporate assets may not be commingled with the personal assets of the shareholders or officers of the corporation.

What are the exceptions to limited liability of the corporate shareholders?

There are some exceptions to the general rule of limited liability of corporate shareholders. A shareholder may be sued personally in the following circumstances:

• A shareholder causes a personal injury to another person
• A personal guaranty of a loan or business debt by the shareholders against corporate default
• Employee wages withheld for taxes are not deposited
• Acts of fraud by shareholders
• Commingling of corporate assets, the corporation is not treated as a separate entity but mixed together with their own assets
• The rules, regulations and formalities for maintaining the corporation are not followed by shareholders

At times there will be challenges to whether a corporation was in existence at the time a certain liability arises, e.g. a defendant acts as if the corporation was legally formed. Limited liability may be lost in such a circumstance, which typically happens where there is a lack of adherence to corporate formality. Such failures include:

• Insufficient captialization of the company - there wasn't enough money invested into the company for the business to operate from the start
• Stock is not issued to shareholders who have formed the corporation
• Regular director meetings are not held with the shareholders
• Business records are not kept or not separated from personal accounts of shareholders

How is a corporation is formed?

The creation of the "Articles of Incorporation" are the first step in creating a corporation. These articles are filed with the division of corporations of the Secretary of State's office along with payment of the required filing fee. The form to incorporate will have basic questions such as the name and address of the business, contact information and telephone number of the registering agent (the person filing the form who is required to be one of the owners of the corporation." Some states require the names of all the directors of the proposed corporation. After the articles of incorporation form is filed, corporate bylaws (rules and regulations of the corporation) must be created, stock certificates issued to the original shareholders and they must be recorded.

What are corporate bylaws?

Corporate bylaws must be drafted and compliance is required for investors to maintain their limited liability status. Bylaws containt the rules and formalities governing how decisions are madein the corporation. Typically they will include how often a board of directors and shareholders are required to meet, votes needed to approve corporate decisions, the manner in which the voting process is to be conducted and the minutes of the corporation kept and other items.

How is the corporate status maintained?

After formation of the corporation, formalities must be adhered to in order for the shareholders to retain their limited laibility status. Such formalities include:

• Scheduling meetings (at least annually) with the board of directors and shareholders
• Minutes of meetings must be kept
• Corporation documents are signed by the corporation in the corporation's name
• A separate bank account in the name of the corporation must be kept
• All income taxes withheld from employees must be deposited into a corporate account
• Financial transactions must be recorded and records maintained
• Corporate income tax returns must be filed

How is filing corporate income taxes different than personal income taxes?

Corporate income tax returns are filed like personal income taxes except in the name of the corporation. They do not have a social security and usually have an EIN or Employee Identification Number. A corporation pays income taxes based upon net profits - the money remaining after all expenses of the business are paid by the corporation. These expenses may include the cost of selling goods and services, wages and salaries of employees (including the owner if he is a corporate employee), employee bonuses, inventory and the operating overhead. Corporations file the IRS Form 1120 for income tax and are subject to special corporate tax rates.