We live in a world where everyone wants to start their own business now. Kudos to you all! Own that business! But what type of business do you want to structure? It’s an important first step in getting your business set up. Have you given it any thought? Some people automatically think they want a corporation because that’s what all these big companies are – corporations, and that’s what we want to be…big. But is the corporate form the correct business structure for you and your business? Let me walk you through an overview of corporations and you decide if it’s the right fit for you.
Corporations are governed by state law. They are created by filing Articles of Incorporation with your Secretary of State (“SOS”) and paying the associated fees, which vary by state. Depending on your state, other documents may need to be filed with the SOS as well, so you must check your state’s requirements to be compliant.
Corporations are owned by its shareholders, governed by its Board of Directors and run by its officers. The Shareholder’s Agreement is an internal document that governs the corporation and includes information regarding the purpose of the corporation, ownership shares, voting for new members, officers and the Board, capital and contribution, allocation of profits and losses, roles and duties of officers, shareholders and the Board, and dissolution. In addition to the Shareholder’s Agreement, the corporation must have employment agreements between the corporation and those employed by the corporation.
Corporations are required to maintain corporate formalities as required by the state of its establishment. There is a requisite number of Board members and roles to be held by the Board. Annual meetings of the shareholders must be held in strict compliance with notice and meeting procedures and protocols. Meeting minutes must be taken and kept on file at the principal place of business for a certain period of time. These are just some of the corporate formalities that are uniform across the states, but it is important that you inquire into what your state’s corporate requirements are and to do all acts to maintain the separation between you as an individual and you as a business owner.
The main advantage of a corporation is that it offers limited liability to its owners, meaning that the shareholders are not individually responsible for the debts of the company. Where a corporation is sued, the plaintiff may only go after the debts of the corporation and cannot reach the assets of the individual owners of the corporation.
The principal disadvantage of the corporate form deals with taxation. Corporations undergo double taxation, meaning that taxes are paid once on the corporate level and again on the personal level when shareholders receive their dividends. In addition, because there are so many corporate formalities (which may vary by state law), corporations are more expensive to set up and maintain. People usually set up their corporations in the state in which they reside or plan to do business, but there is a trend for larger companies to incorporate in Delaware or Nevada due to their low costs and minimal taxes.
Failure to maintain the separation between yourself and your entity will expose you to individual personal liability. Where a party can show that you created a corporation for the sole purpose of avoiding individual personal liability, the corporate veil can be pierced, and you will be subject to personal liability. In laymen’s terms, if you create a business and run the business as an extension of yourself, if you are sued in your business capacity, and the party suing can prove that your business is really just a sham as you are just incurring debts and liabilities in the name of a company that does not really exist, then not only can that party come after all of the assets of your business, but it can come after you and all of your personal assets as well. If the business is sued, a grieving party only has rights to what the business has, so if your business has $48 of assets, that’s all they’re getting. But if the business is sued and corporate formalities were not maintained, and the corporate veil is pierced, a grieving party can come after you, your house, your car, your bank account, and your dog (lol, you get the point).
Types of Corporations
There are three (3) different types of corporations, and they are (1) for profit corporations, (2) non-profit corporations and (3) closely held corporations. Profit Corporations are the ones previously described hereinabove, and they may or may not sell shares in an open market. Non-Profit Corporations typically run to further an ideal or goal and are less centered on making a profit. They usually serve the interests of the public interest. Some non-profits do engage in private sector activities. Closely Held Corporations are corporations with a limited number of shareholders. These are usually family owned business where the owners actually operate the business from day to day. There are limits on the number of shares of stock and strict rules against transferability.
Corporations can additionally be divided into two (2) categories: C-Corporations and S-Corporations. C-Corp’s are the ones I’ve just previously described. The majority of corporations fall into this category. C-corps are subject to double taxation where funds are taxed first at the corporate level and again once dividends are distributed to its owners (shareholders). Then we have S-Corps. S-Corps are not registered with the SOS, instead they are filed with the Internal Revenue Service. S-Corp is a tax designation that can be granted to a corporation or limited liability company. If certain requirements are met, and S-Corp status is granted and maintained, corporations can avoid double taxation and be taxed the same manner as partnerships. The requirements of S-Corp status are:
- There must be 100 shareholders (owners) or less (closely held corporations);
- All shareholders must be individuals (no corporate entities, trusts, etc.);
- The corporation must be domestic (US citizenship for shareholders); and,
- The corporation is limited to one class of stock.
The benefits of an S-Corp include:
- It creates credibility with potential consumers, investors, and employees by showing a commitment to the company;
- The shareholders may be employees and receive tax-free distributions in relation to their ownership share;
- The characterization of distributions as salary or dividend may save owners with employment taxes;
- Federal taxes are not paid at corporate level. They are only paid once distributed to owners who then pay for their individual tax based on their share, which can also be offset by other income on shareholder’s taxes; and,
- Interests in an S-Corp are easily transferable without adverse tax consequences (e.g. change in property basis).
There are some drawbacks to S-Corp status, and they include:
- Since it is an IRS designation and the IRS don’t play about granting benefits, this S-Corp status is under strict IRS scrutiny;
- You can lose S-Corp status if there are mistakes in filing, stock ownership, notification, consent, etc.
- There are some fees (not excessive, but some) associated with S-Corp including, registration of the corporation or LLC with SOS, annual report fees, state franchise fees, etc.
You can tell by the length of this blog that a lot goes into establishing and maintaining a corporation. You should certainly consult an attorney to discuss the details of your business idea to learn if the corporate structure is right for your business. At this stage in your business, a different entity type may be better suited to your needs. You may have the option to change your entity type later as your business grows and develops if it necessitates a different structure to accommodate your business needs.
Lerae Funderburg, Esq. is the Managing Attorney at Funderburg Law, LLC, an Atlanta based law firm specializing in business, estate planning and entertainment transactions. As a lawyer and blogger, Lerae keeps her viewers and subscribers up to date with legal news, especially in the areas of business, estate planning, music, copyright law and trademark law. If you are local to Atlanta, call and set up a consultation! She would love to hear from you!