There are elements to a corporation that set it apart from other legal business entities.
A corporation has:
- shares and shareholders (in most instances)
- a board of directors
- 21% corporate tax rate or S corporation
- complex operational rules and regulations
Shares and Shareholders
A share of stock is the unit of ownership of a corporation. Each share of stock represents a percentage of ownership of the company. For example, if a corporation issues one share of stock the shareholder (stock owner) would then own 100% of the corporation.
Shares can be structured into classes. Each class, termed a share class, holds different rights and privileges. A corporation can have multiple classes and each class can hold any number of shares.
Authorized Shares: the number of shares the corporation is allowed to issue.
Issued Shares: the total number of shares actually issued to shareholders.
Share Class: a group of shares that has a unique set of rights and privileges.
Board of Directors
When a corporation is formed, the state's required number of directors must be appointed until the first shareholders’ meeting.
A corporate director is in charge of the adoption, amendment, and repeal of operational bylaws as well as the election, supervision, and removal of officers.
After forming the corporation, the incorporator(s) — or initial director(s), if named on the formation documents — should call an organizational meeting.
During this initial meeting, either the incorporator(s) will officially elect the board of directors or the initial director(s) will appoint the officers.
Bylaws are the rules that determine how a corporation will be governed and run. You can think of bylaws as a constitution for a corporation. It makes the rules and priorities clear for everyone involved.
TIP: There are bylaws templates available to help business owners form corporations.
A corporation’s bylaws will supplement any rules set forth by the federal government or the state.
Corporate bylaws should include:
- How the corporation will be governed, including the role of directors and officers
- How meetings are held, voting procedures, electing officers or directors
- How records will be kept and managed
- How disputes will be handled
- How bylaws will be added/amended in the future
- The date of the annual shareholders' meeting
- How to negotiate contracts
- Fiduciary duties to the corporation (i.e. acting in the best interests of the corporation)
- What constitutes a quorum for voting purposes
What is a Quorum? A quorum is the minimum number of members of an assembly that must be present at a meeting to make the meeting valid, or any of the votes held therein.
Corporations pay a federal corporate tax rate of 21%.
Corporations distribute their profits to shareholders in the form of dividends. Shareholders then have to pay personal income tax on these dividends. Because the profits of the company have already been taxed at the corporate level, corporations are said to be “double taxed".
The tax rate on ordinary dividends is the same as the individual federal income tax rate, which means it will vary depending on your income.
C Corporation vs S Corporation
A C corporation's net profit is subject to corporate income tax but an S corporation isn't taxed at the corporate level.
An S corporation is an IRS tax designation. A corporation that is taxed as an S corp isn't subject to double taxation. Instead, profit passes through to the shareholders' individual tax returns in the form of distributions.
Owners in an S corp must also be paid a reasonable salary. The salary is subject to income tax and full FICA taxes but distributions are only subject to income tax.
Only corporations that prefer to not re-invest profit to grow the business should form an S corp. This is because it only makes sense to file taxes as an S corp if most of the profit is paid to shareholders in the form of salaries and distributions.
To learn more about the differences between a C Corp and an S Corp, read our guide.
Running a Corporation
In order to protect your personal assets, and not allow creditors or municipalities to pierce your corporate veil, you must:
- Maintain up-to-date bylaws
- Set up a corporate records book
- Hold required annual meetings
- Give notice of meetings when applicable
- Keep accurate meeting minutes
Learn more about running a corporation in our How To Start a Corporation guide. If you’d like to know more about hiring a professional service to set up a corporation for you, take a look at our Top 7 Business Formation Services review.
When To Form A Corporation
If a business carries any risk or earns a profit, then you need to form a legal business entity.
This is because legal business entities like corporations and LLCs protect their owner's personal assets in the event that a business is sued or if they are unable to repay a business debt.
Legal business entities can provide a safe separation between you and your business when the corporate veil is properly maintained.
Corporation vs LLC
Most small businesses start as limited liability companies (LLCs) but there are some instances when starting as a corporation makes sense.
Your small business would benefit from a corporate structure if:
- you need to carry significant profit over from tax year to tax year
- you need to attract venture capitalist and investors
- there is benefit in managing a complex business structure
Profit Carryover from Year to Year
If a small business is unable to spend a significant amount of its profit during a tax year on expenses to grow the business, it could make sense to structure the business as a corporation rather than an LLC. This is because of the difference in the way the two business entities are taxed.
A corporation is taxed at about 15% for all profits that carry over to the next tax year. In this same scenario, an LLC member's tax burden would be greater because they pay FICA taxes and federal and state income taxes, which are higher than the 15% corporate rate.
That said, a business owner who anticipates needing to carry profit into the next tax year should look closely at the financial benefits of forming a corporation.
Venture Capital and Investors
If you need to attract investors, starting a corporation could be the best choice for your small business.
An investor in a corporation pays taxes on dividends only when they receive them whereas an investor in an LLC would have to pay taxes regardless of whether they received a distribution or not. The LLC investor might never see a return on their investment but might have to pay taxes every year regardless. This is why investors prefer C corps.
Managing a Complex Business Structure
If the benefits of managing a complex business structure outweigh the costs, starting a corporation could make sense for your small business.
Corporations are more complex organizations compared to LLCs, with increased administrative overhead, more paperwork, and complex compliance requirements. Managing a corporation may require help from an attorney or accountant which can increase overall business costs.