Entrepreneur: Corporation – Entrepreneur Small Business Encyclopedia

A corporate structure is perhaps the most advantageous way to
start a business because the corporation exists as a separate
entity. In general, a corporation has all the legal rights of an
individual, except for the right to vote and certain other
limitations. Corporations are given the right to exist by the state
that issues their charter. If you incorporate in one state to take
advantage of liberal corporate laws but do business in another
state, you’ll have to file for “qualification” in the state in
which you wish to operate the business. There’s usually a fee that
must be paid to qualify to do business in a state.

You can incorporate your business by filing articles of
incorporation with the appropriate agency in your state. Usually,
only one corporation can have any given name in each state. After
incorporation, stock is issued to the company’s shareholders in
exchange for the cash or other assets they transfer to it in return
for that stock. Once a year, the shareholders elect the board of
directors, who meet to discuss and guide corporate affairs anywhere
from once a month to once a year.

Each year, the directors elect officers such as a president,
secretary and treasurer to conduct the day-to-day affairs of the
corporate business. There also may be additional officers such as
vice presidents, if the directors so decide. Along with the
articles of incorporation, the directors and shareholders usually
adopt corporate bylaws that govern the powers and authority of the
directors, officers and shareholders.

Even small, private, professional corporations, such as a legal
or dental practice, need to adhere to the principles that govern a
corporation. For instance, upon incorporation, common stock needs
to be distributed to the shareholders and a board of directors
elected. If there’s only one person forming the corporation, that
person is the sole shareholder of stock in the corporation and can
elect himself or herself to the board of directors as well as any
other individuals that person deems appropriate.

Corporations, if properly formed, capitalized and operated
(including appropriate annual meetings of shareholders and
directors) limit the liability of their shareholders. Even if the
corporation is not successful or is held liable for damages in a
lawsuit, the most a shareholder can lose is his or her investment
in the stock. The shareholder’s personal assets are not on the line
for corporate liabilities.

Corporations file Form 1120 with the IRS and pay their own
taxes. Salaries paid to shareholders who are employees of the
corporation are deductible. But dividends paid to shareholders
aren’t deductible and therefore don’t reduce the corporation’s tax
liability. A corporation must end its tax year on December 31 if it
derives its income primarily from personal services (such as dental
care, legal counseling, business consulting and so on) provided by
its shareholders.

If the corporation is small, the shareholders should prepare and
sign a shareholders buy-sell agreement. This contract provides that
if a shareholder dies or wants to sell his or her stock, it must
first be offered to the surviving shareholders. It also may provide
for a method to determine the fair price that should be paid for
those shares. Such agreements are usually funded with life
insurance to purchase the stock of deceased shareholders.

If a corporation is large and sells its shares to many
individuals, it may have to register with the Securities and
Exchange Commission (SEC) or state regulatory bodies. More common
is the corporation with only a few shareholders, which can issue
its shares without any such registration under private offering
exemptions. For a small corporation, responsibilities of the
shareholders can be defined in the corporate minutes, and a
shareholder who wants to leave can be accommodated without many
legal hassles. Also, until your small corporation has operated
successfully for many years, you will most likely still have to
accept personal liability for any loans made by banks or other
lenders to your corporation.

While some people feel that a corporation enhances the image of
a small business, one disadvantage is the potential double
taxation: The corporation must pay taxes on its net income, and
shareholders must also pay taxes on any dividends received from the
corporation. Business owners often increase their own salaries to
reduce or wipe out corporate profits and thereby lower the
possibility of having those profits taxed twice-once to the
corporation and again to the shareholders upon receipt of dividends
from the corporation.