The last post looked at 3 business entities – the sole proprietorship, the general partnership, and the limited partnership. Here, we take a look at corporations and, in the following post, limited liability companies.
A corporation is a business entity that is separate from its owners (shareholders) and, therefore, offers its owners limited liability. Corporations must follow specific rules of operation, or there may be a “piercing of the corporate veil,” meaning the owners may become liable for more than their initial investment in the company. Corporations may be “publicly” or “privately” held and follow two basic structures regarding tax treatment: C Corporations and S Corporations.
The traditional form of corporation is a C Corporation. Most are privately or closely held, meaning their stock is not publicly traded in a market. However, the mega-companies people come into contact with every day are usually publicly traded C Corporations. Shareholders of smaller C Corporations often also act as directors and officers of the company, whereas larger C Corporations generally have a board of directors and officers distinct from their shareholders.
Formation and operation of a C Corporation is somewhat complex, as particular rules and formalities must be followed. To initiate the company, a promoter must file appropriate documents with the Illinois Secretary of State, which include the articles of incorporation. Next, directors must be appointed and bylaws must be created. Finally, all necessary permits and licenses required for operating the business must be obtained.
Once formed, the corporation must adhere to various formalities, including holding regular meetings of the board of directors and shareholders. Minutes of meetings must be kept and corporate action must be properly documented. Finally, an issue that may be overplayed at times, but must be taken into account is the “double taxation” problem C Corporations face. Simply put, double taxation means that corporate income is subject to income tax and the shareholders are also subject to income tax on dividends they are paid from the corporation.
S Corporations are set up and run similar to C Corporations, but differ in tax treatment. S Corporations are flow through entities and are not subject to double taxation as discussed above. The S Corporation’s income is reported on each shareholders personal income taxes, based on their percentage of shares owned. In return for this benefit, S Corporations must adhere to limitations not placed on C Corporations, most notable of which involves the number and types of shareholders allowed. Otherwise, S Corporations must be governed in a manner similar to C Corporations.
The next post will discuss what is, in many instances, the best form of organization for small businesses, the Limited Liability Company.