Incorporation Law
A corporation is a legal entity that can exist separately from its owners. Creation of a corporation occurs when properly completed articles of incorporation (called a charter or certificate of incorporation in some states) are filed with the proper state authority, and all fees are paid. Individual states have the power to create laws relating to the creation, organization and dissolution of corporations. State corporation laws require articles of incorporation to document the corporation's creation and to provide provisions regarding the management of internal affairs. Most state corporation statutes also operate under the assumption that each corporation will adopt bylaws to define the rights and obligations of officers, persons and groups within its structure. States also have registration laws requiring corporations that incorporate in other states to request permission to do in-state business.
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Securities Act of 1933
Another major factor of Federal corporations law came about when Congress passed the Securities Act of 1933 , which regulates how corporate securities are issued and sold. Federal securities law also governs requirements of fiduciary conduct such as requiring corporations to make full disclosures to shareholders and investors.
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Incorporation Advantages
One of the primary advantages of incorporation is the limited liability the corporate entity affords its shareholders. Usually, shareholders and directors are not liable for the debts and obligations of the corporation. In a partnership or sole proprietorship the owner's personal assets may be used to pay debts of the business. The law treats a corporation as a legal "person" that has standing to sue and be sued, distinct from its stockholders. It also allows stockholders to sue the corporation through a derivative suit and makes ownership in the company (shares) easily transferable. The legal "person" status of corporations gives the business perpetual life; deaths of officials or stockholders do not alter the corporation's structure.
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Incorporation Disadvantages
The primary disadvantage to a corporation is double taxation. Profits of a corporation are taxed twice when the profits are distributed to shareholders as dividends. They are taxed first as income to the corporation, then as income to the shareholder. All reasonable business expenses such as salaries are deductions against corporate income and can minimize the double tax. The double tax can be eliminated by forming an S corporation. Corporations are taxable entities that fall under a different scheme from individuals. Although corporations have a "double tax" problem, corporate profits are taxed at a lower rate than rates for individuals.
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S Corporation
Standard business corporations (C corporations) are required to pay income tax on taxable income generated by the corporation. Making a subchapter S election by completing and filing federal Form 2553 with the IRS is a way to avoid double taxation.
An S corporation is a standard business corporation that has elected a special tax status with the IRS. This tax treatment allows the corporation not to be a separately taxable entity. Instead, the income of the corporation is treated like the income of a partnership or sole proprietorship; the income is "passed-through" to the shareholders. Thus, shareholders' individual tax returns report the income or loss generated by an S corporation.
To be classified as an S corporation, a corporation must make a timely filing of Form 2553 with the IRS. IRS instructions indicate you must complete and file this form:
- at any time before the 16th day of the 3rd month of the tax year the election is to take effect, or
- at any time during the tax year preceding the tax year it is to take effect. An election made no later than 2 months and 15 days after the beginning of a tax year that is less than 2½ months long is treated as timely made for that tax year.
An election made after the 15th day of the 3rd month but before the end of the tax year generally is effective for the next tax year. However, an election made after the 15th day of the 3rd month will be accepted as timely filed if the corporation can show that the failure to file on time was due to reasonable cause.
In order to qualify for S corporation status, the corporation can have no more than 100 shareholders, who must all consent in writing to the election to be an S corporation. The shareholders cannot be non-resident aliens. Also, an S corporation can have only one class of stock (disregarding voting rights).
Please note, corporations in certain states are required to complete state-specific S corporation election forms for state taxation purposes. Additionally, certain states do not recognize federal S corporation status for state taxation purposes. Contact your state of formation's department of taxation for more information on its S corporation requirements.
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