Most frequent questions and answers

There are two types of corporations under which you may want to set up a business structure: a C corporation or an S corporation.

A C corporation is a form of business that is completely separate from the owners and managers. It has a “life of its own.” A major advantage to a corporation is that, in most instances, individual owners (shareholders), directors and employees do not assume personal liability for its actions.

Some important features of a corporation include the following:

  • A corporation is state-charter based on where its headquarters are located.
  • A corporation has a perpetual life and ceases to exist only when it is formally dissolved.
  • The corporation is owned by the shareholders, who elect the board of directors.
  • The board directs corporate strategies and policies. The board also elects the corporate officers (president, vice president, secretary and treasurer).

The percent of stock owned by a shareholder governs the amount of voting power he or she has. The vote of a shareholder who owns more than half the stock (51 percent) will be able to control the outcome of any ballot, so that shareholder is considered to have a controlling interest.

Only one shareholder is required, and one person can comprise the board of directors and all corporate officers.

Forming a C corporation calls for meeting requirements set forth by your state. An Internet search under “[your state name] Secretary of State” should lead you to the forms you will need.

Steps that you will take to incorporate include:

  1. File the forms for your state’s articles of incorporation and pay the incorporation fee.
  2. Establish corporate bylaws and maintain a minute book to record board of directors’ meetings and the corporation’s annual meeting.
  3. Distribute stock certificates to shareholders.

Once you have incorporated, you will be required to hold an annual shareholder meeting, file an annual report with your Secretary of State, and pay any required annual fees.

The forms will ask you to list the business’s official corporate name and the purpose of the business, the name and address of the registered agent, and details of share ownership.

This is an important decision. To avoid potential legal problems, you must avoid choosing a name that duplicates or can be considered too close to a name used by an existing business. Your state will make sure that you do not duplicate a name that is registered with the State, but you may want to do a national search for an identical or nearly identical name, especially if you intend to do business outside of your state.

You will also want to make sure that the business name includes the words “corporation,” “company,”  or “incorporated,” or an abbreviation of those words.

A registered agent is a person or entity who will receive tax and legal documents for the corporation. This can be a manager or shareholder of the company, or there are services that will handle the function for a fee as indicated above. You can save hundreds of dollars a year by becoming the registered agent for your own corporation. The registered agent must have a legal address within the state or jurisdiction that the registration covers. The corporation may be invalidated if the registered agent is not maintained.

Like a proprietorship or partnership, a corporation can borrow money from a bank or other lender. But it can also raise funds by selling stock to shareholders. This money becomes a permanent part of the company’s resources and does not have to be repaid as a loan does.

One of the continuing duties of a corporation is to maintain business and accounting records. It will need to keep the following at its home office:

  • articles of incorporation and bylaws and any amendments that are up-to-date;
  • any resolutions adopted by the board;
  • copies of written messages to shareholders, including financial statements that are required for shareholders;
  • names and addresses of directors and officers; and
  • the annual report most recently filed with the Secretary of State.

One of the drawbacks to the owners of a C corporation is the potential for income to be taxed twice – first as a corporation and second as a shareholder.

This can happen because the C corporation files its own tax returns as a stand-alone entity and pays any taxes that are due. The corporation then pays after-tax profits to shareholders in the form of dividends, and the shareholders will most likely have to pay personal income tax on the dividend money.

If the shareholder is also an employee, the company can pay the shareholder-employee a salary, as long as it is considered a reasonable amount. The corporation can deduct the salary as a business expense so that it is taxed only once (as income by the employee).

Another option is to elect Subchapter S status if the business qualifies.

As a shareholder, you are not liable for the debts and liabilities of a corporation. Generally, you are not risking your personal assets. You may, however, lose the amount of your investment if the corporation is not profitable or ceases to stay in business.

You may also be at risk if you personally guarantee a debt of the business. Also, if the corporation does not follow legal requirements or if corporate and personal funds are commingled, you might be liable.

Yes, directors, as well as corporate officers or employees, can be considered liable. This can be a problem in attracting directors or employees with the needed expertise. Companies can purchase insurance that will provide compensation for losses sustained due to actions of the directors and employees while they are performing their responsibilities to the corporation.

In addition, depending on the nature of the business, the corporation’s leaders must be sure that the insurance is sufficient to protect the corporation from losses due to property damage or personal injury.

You need to gain shareholder approval and file a notice with the Secretary of State. After taxes and other debts are paid, any remaining assets are distributed to shareholders.

Incorporating an S corporation includes the same procedures and filings as a C corporation. The owners must elect Subchapter S status with the IRS by filing Form 2553, Election by a Small Business Corporation, and they must meet certain criteria.

All of these criteria must be met in order to qualify as an S corporation:

  • Domestic corporation: organized under the laws of the United States, a state, or a territory;
  • Shareholders: cannot be a nonresident alien; cannot be a partnership or a corporation and must meet additional similar measures;
  • Number of shareholders: cannot be more than 75;
  • Stock: can only be one class of common stock with no preferred stock; and
  • Certain types of corporations: are not allowed, such as an insurance company or a domestic international sales corporation.

Since an S corporation is treated like a partnership for tax purposes, each shareholder’s portion of the profit or loss is included on his or her federal and state tax returns. This means that profits from the S corporation are only taxed once at the individual’s personal tax rate. Shareholders are personally responsible for any related taxes and for estimated income taxes.

So profit and loss are allocated among shareholders just the way it is done for a partnership?

For an S corporation, profits and losses are allotted in the same proportion as the stock ownership. If someone owns 10 percent of the stock, their share of the profit or loss is 10 percent. This might differ from the allocation of a partnership, as a partnership agreement can specify a distribution of the profit or loss that might be different that the proportion of stock ownership.

Other than its distinctive tax treatment, an S corporation has the same features as a C corporation. That is, beyond his or her investment in the business, a shareholder is not personally at risk for debts or other liabilities of the business.

Yes, if certain of rules are followed:

  • All shareholders must agree to the election.
  • No more than 25 percent of the company’s gross receipts during the 3 prior years may be considered passive income (such as rent from a real estate investment).

Timing is important in becoming a S corporation. If you want to convert from a C to an S corporation immediately after starting the business, you must file with the IRS within the first 2½ months of the company’s first taxable year. If you do not meet the deadline, your business will be taxed as a C corporation.

If your business has been ongoing for some time as a C corporation, you can still elect Subchapter S status if you file with the IRS during the 12 months before the tax year that you want the company’s status to change.

Yes, if the conditions for an S corporation are no longer being met.

An S corporation can own 80 percent or more of a C corporation. It can also hold subsidiaries if it meets certain qualifications.

When you start a business, the typical way to fund the operation of the business is to purchase stock in the business if the entity is a corporation. This process is called “capitalizing” the corporation. Another method of capitalizing the corporation is to loan the corporation funds, usually from the majority shareholder. Many corporations use a combination of stock purchases and loans to capitalize their business entity.

Another method is the purchase of business assets from another business. A purchase of business assets for the purpose of beginning a new business will generally take two forms: the purchase of an entire business or the purchase of specific assets and equipment only.