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Corporation (Inc.)

 

Frequently Asked Questions regarding Corporations

  1. Why form a corporation?
  2. How does the corporate management structure work?
  3. Who can form a corporation?
  4. Which corporate tax structure is better, a C-corporation or a S-corporation?
  5. What are the differences between a corporation, LLC, sole-proprietorship, and partnership?
  6. Should I form my corporation in a different state?
  7. Do I need an attorney to form a corporation?
  8. What is a Registered Agent?

1. Why form a corporation?
Below are some of the benefits of forming a corporation:

  • The owners are protected from the corporation’s debt, lawsuits, and other business related liabilities.
  • The corporate structure makes it easier to raise capital by selling stock to investors.
  • The corporate structure can reduce taxes by avoiding self-employment tax and utilizing income splitting strategies.
  • A corporation has a perpetual life. This means that the business continues to exist even if the owners leave the company or dies.
  • The corporate structure can help develop credibility and professionalism.
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2. How does the corporate management structure work?
In order to understand the corporate structure, you must first understand the key players and their role in the corporation.

Corporate Players Role in the corporation
Shareholders Shareholders are the owners of the corporation.
Directors The shareholders will elect directors; the directors’ general duties are to create corporate policies and manage corporate affairs. The directors’ duties include hiring officers, reviewing and approving budgets, and dealing with corporate governance matters.
Officers The officers are the President, Vice-President, Treasurer, and Secretary. These individuals are in charge of the day-to-day business activities.


In a corporation, the shareholders will elect the directors (the policy makers/managers of corporate affairs). The directors will then hire officers to run the day-to-day operations. In most small businesses, the shareholders, directors, and officers are usually the same people.

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3. Who can form a corporation?
Generally, there are no ownership restrictions for a C-corporation. However, if you are forming a S-corporation, there are some ownership restrictions that you must comply with. Click here for a summary of the S-Corporation ownership restrictions.

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4. Which corporate tax structure is better, a C-corporation or a S-corporation?
Below is a brief overview of the common reasons why businesses choose one tax structure over the other:

  • S-corporation: Most small businesses tend to choose the S-corporation because of its pass through taxation and the ability to avoid paying self-employment taxes on the pass through profits. However, one drawback of a S-corporation is that you must distribute all profits to the owners. You do not have the ability to retain the profits within the company. Additionally, there are ownership restrictions in order to be taxed as a S-Corporation. Click here for a summary of the S-Corporation ownership restrictions.
  • C-corporation: Businesses that want to retain the profits within the company in order to grow the business would typically form a C-corporation instead (can later be converted to a S-corporation by a simple IRS filing). When taxed as a C-corporation, the corporation’s profits will be taxed at the corporate level as business income and any profits distributed to the owners will be taxed as income to the owner thus causing double taxation. However, a C-corporation does not have to distribute the profits to the owner and may choose to only distribute a portion of the profits to its owners and retain the difference (i.e. ABC Company profits $100,000 this year and distributes $30,000 in dividends to owners and retains the $70,000 for the company’s use). Only profits that are distributed to the owners will be taxed twice (taxed at corporate and individual level). The profits that are left as retained earnings will only be taxed once at the corporate level

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5. What are the differences between a corporation, LLC, sole-proprietorship, and partnership?
Below is a chart to help you compare the differences between the most common business structures:

  Sole Proprietorship Partnership LLC S-corporation C-corporation

Ownership

Requirement
1 owner. 2 or more owners.

1 or more owners.

Between 1 to 100 owners. Click here for details. 1 or more owners.
Liability Protection No, the owner is personally liable. No, the partners are personally liable. Yes, generally the owners are protected from personal liability. Yes, generally the owners are protected from personal liability. Yes, generally the owners are protected from personal liability.
Perpetual Existence No, this structure ends when the owner dies or withdraws. No, this structure ends when the owner dies or withdraws. Maybe, a LLC’s life will depend on the state of formation. Yes, a corporation continues to exist after an owner dies or withdraws. Yes, a corporation continues to exist after an owner dies or withdraws.
Taxation Profits are only taxed at the individual level, also known as “pass through taxation.” Profits are only taxed at the individual level, also known as “pass through taxation.” Flexible tax structure (LLCs can choose to be taxed as a sole proprietorship, partnership, S-corp, or C-corp). Profits are only taxed at the individual level, also known as “pass through taxation.” Profits are taxed at the corporate level and any profits distributed to the owners will be taxed again at the individual level, also known as “double taxation.”
Self Employment Tax Yes, profits are typically subject to SE Tax. Yes, profits are typically subject to SE Tax. Maybe, it will depend on the tax structure selected. No, profits are typically not subject to SE Tax. No, profits are typically not subject to SE Tax.
Passive Investment Income Yes, this structure can be used for passive investment income (i.e. rental income, royalties, etc.). Yes, this structure can be used for passive investment income (i.e. rental income, royalties, etc.). Yes, this structure can be used for passive investment income. However, there is a 25% income rule if you elect to be taxed as a S-Corporation. Yes, this structure can be used for passive investment income. However, there is a 25% income rule if you elect to be taxed as a S-Corporation. Yes, this structure can be used for passive investment income (i.e. rental income, royalties, etc.).
Professional Services Yes, this structure can be used professional services (i.e. doctors, lawyers, etc.) Yes, this structure can be used professional services (i.e. doctors, lawyers, etc.) Maybe, it will depend on the state where business is being conducted. Maybe, it will depend on the state where business is being conducted. Yes, this structure can be used professional services. However, there is a special federal PSC 35% flat tax.
Formalities Few formalities. Business must comply with DBA laws. Few formalities. Business must comply with DBA laws. Must comply with state reporting requirements, if any. Corporations must hold annual meeting and comply with state reporting requirements. Corporations must hold annual meeting and comply with state reporting requirements.
Disadvantages No liability protection and must also pay SE tax on income. No liability protection and must also pay SE tax on income. Higher start-up cost, more formalities, and higher maintenance cost. Higher start-up cost, more formalities, and higher maintenance cost. Higher start-up cost, more formalities, higher maintenance cost, and double-taxation.
Advantages Few formalities and low start-up costs. Few formalities and low start-up costs. Personal liability protection, flexible tax structure, and no annual meeting requirement. Personal liability protection and possible SE tax savings. Personal liability protection and the ability to retain earnings and to split income.
Usage For businesses that have low liabilities or new start-ups with low capital. For businesses that have low liabilities or new start-ups with low capital. For businesses that want personal liability protection and a flexible tax structure. For businesses that want personal liability protection and possible SE tax savings. For businesses that want personal liability protection and prefer to keep some or all of the profits within the business.

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6. Should I form my corporation in another state?
Most small businesses will form a corporation in their home state (the state where their business is located). Filing in another state will usually require more paperwork, additional maintenance fees, and additional state taxes (where applicable).

If you intend to conduct business in only one state and do not expect any major corporate governance issues (shareholder/investor disputes, director disputes, company policy disputes, etc.), then you should consider forming a corporation in your home state. This is because the additional paperwork, fees, and taxes usually outweigh the benefits of forming a corporation in a more business friendly state.

However, if the corporation will seek funding from venture capitalists, professional investors, a public stock offering, or expect corporate governance issues, then you should consider forming a corporation in a more business friendly state (i.e. Delaware, Nevada, etc). The major benefit of forming a corporation in another state is the quick and predictable results from corporate governance lawsuits.

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7. Do I need an attorney to form a corporation?
No. You can always prepare and file your own formation documents. My Legal Depot can help you incorporate and save money on attorney fees. However, if you need legal advice, you should consult an attorney.

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8. What is a registered agent?
All corporations must designate a registered agent who is available during normal business hours to accept notices and documents. The registered agent may either be: (1) an adult individual residing in the state of incorporation OR (2) a company authorized by the Secretary of State to serve as agent (such as My Legal Depot).

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