Corporations --The Basics
(c) 1996 Philip R. Green
What a corporation is, unique to this form of business, is a separate legal entity or a
"person," that has its own separate "legal" identity for tax and
liability purposes. Many people desire to turn their business into a corporation or
initiate it as a corporation, and there are many reasons to incorporate. Many of the older
reasons for incorporation do not exist any longer. With changes to the tax laws that can
make corporate rates higher or lower than individual rates, the corporation is not always
the preferred business form and the form should be reviewed annually.
Formation of the corporation is done by filing Articles of Incorporation with the Secretary of State and a Statement of Domestic Stock Corporation (within 90 days after the articles and each year thereafter). Other licenses and permits as necessary should be applied for. The cost to incorporate is higher than the cost to create a partnership or other form of business entity because there are the legal and accounting costs to prepare documents and fees and taxes to be paid: prepayment of tax to the State Franchise Tax Board ($800.00 in California) and a Secretary of State filing fee.
One of the best things about a corporation is that it can limit the liability of the shareholders and other individuals involved with it. Another good reason to incorporate is that it can sell shares which provides equity that can take the form of bonds, indentures and notes. This provides a capital raising feature. Partnerships must depend on contributions and loans from partners and others while corporations can issue and sell shares. The sale of shares can be used for tax planning purposes. Internal Revenue Code Sec. 1244 provides for the use of shares in tax planning, where there are losses on stock. Whenever tax planning is a consideration of incorporating, a qualified CPA should be consulted regarding the financial and bookkeeping aspects of corporations.
Under the corporate form of business, central control and management can be separated from ownership by using such devices as non-voting stock, "close" corporations, shareholder agreements, "super majority" vote requirements and other techniques to limit or manage the running of the corporation.
A corporation has perpetual existence. The individuals might die or retire but the corporation can go on doing business. A corporation may be dissolved either voluntarily or involuntary (such as through bankruptcy) and/or a corporation's powers may be suspended for failure to comply with corporate formalities, such as failure to pay the annual franchise tax required in most states (which is a minimum, whether the corporation makes any money or not) or the corporation's business may simply fail or be sold to another.
Caution must be exercised before selling stock, for unless it is exempt from being "qualified" under the law, it usually must be pre-qualified by the Secretary of State of the state of incorporation. There are small-offering exemptions, however, if less than 35 persons are offered the stock in any single offering, and those persons have a "pre-existing personal or business relationship with the offeror," the person buys for his/her own account, and the offering is not advertised, broadly speaking. The qualification process is cumbersome and costly, and few "sole" or small corporations would have to follow this procedure.
See the article on Corporate Liability regarding this subject.