Corporations are a common form of business entity, but in recent years limited liability companies have become more popular.
When a corporation is formed, it is regarded by the law as a separate legal entity from its owners, directors, officers and employees. In fact, courts refer to corporations as “fictitious persons.”
Forming a corporation requires filing Articles of Incorporation with the Missouri Secretary of State. If the Secretary of State finds that the articles are in proper form, a Certificate of Incorporation is issued and a registration number assigned, at which point the corporation comes into existence.
A corporation is a structured organization which allows for one or more owners and centralized management. The owners of a corporation are called shareholders because they own shares of stock in the corporation representing their ownership interests.
One advantage of incorporation is insulating the shareholder owners from personal liability for the activities and obligations of the corporation. Subject to certain rare exceptions, a creditor cannot enforce a corporate obligation against individual shareholders, but can only collect from corporate assets. Thus, while a shareholder could lose part or all of his or her investment in the corporation to a corporate creditor, the shareholder’s other personal assets are protected.
Another advantage of incorporation is that it allows for raising capital by selling stock or corporate bonds. Other types of business organizations typically are limited to raising capital through contributions or loans from their existing owners or through loans from banks and third parties.
The basic management structure of a corporation is as follows:
- Shareholders elect the members of the board of directors.
- The board of directors in turn selects officers and sets policies.
- The officers manage the day-to-day business of the corporation under the board’s supervision and subject to its policies.
If corporation is profitable, its shareholders can receive a return on their investment through the payment of dividends. Dividends must be approved by the board of directors and are taxable to the shareholders as ordinary income.
Unless a corporation elects special tax treatment under Subchapter S of the Internal Revenue Code, the corporation’s net income is subject to taxation at rates sometimes higher than those applying to individuals. This raises the possibility of double taxation of dividends – the money is taxed once at the corporate level and again at the personal level when reported on shareholders’ personal tax returns.
To avoid this double-taxation effect, subject to certain restrictions, a corporation can elect a different tax treatment under Subchapter S of the Internal Revenue Code. If this election is made, the corporation is treated virtually the same as a partnership for tax purposes. Although the corporation must file an informational return with the IRS, its net income is not taxed at the corporate level but rather is “passed through” to the shareholders for reporting on their personal returns. Corporate losses can also pass through and be taken as losses on the shareholders’ personal returns. Consultation with an accountant is highly recommended before deciding whether to elect Subchapter S.
Dividends are not the only way shareholders can receive money from a corporation. Additional possibilities include:
- A stockholder can be paid a salary if employed by the corporation. If the salary is reasonable, it will be a deductible expense in its entirety for the corporation. Of course, the salary will be taxable to the stockholder.
- If a stockholder has loaned money to the corporation (as distinct from purchasing stock), the corporation’s principal repayments will be non-taxable to the stockholder while the interest payments will be taxable. The corporation can deduct the interest payments but not the principal payments.
- If a stockholder leases real or personal property to the corporation, the rent payments will be deductible for the corporation and taxable to the stockholder.
Scott Law Firm provides legal services in forming and maintaining corporations. In most cases we charge a fixed fee for incorporating a new business corporation.
Contact us for further information.
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