What is a Corporation?

A corporation is a legal entity that is owned by shareholders and ran by a board of directors.

Corporations have many of the rights that individuals have. They can own assets, enter into contracts, borrow and lend money, and sue and be sued.

Small businesses form corporations to attract investors and provide limited liability protection.

Learn more about forming a corporation for your small business or startup in our What is a Corporation guide below.

Need Help Choosing a Business Structure? Visit our How to Choose a Business Structure guide.

When to Form a Corporation for a Small Business

Most small business owners should form a separate legal entity to protect their personal assets. This protection is called limited liability protection and without it, a business owner can be held personally liable in the event of a lawsuit or bankruptcy.

You can get limited liability protection by forming a limited liability company (LLC) or corporation.

Corporations are an excellent choice for small businesses and startups that will rely on investors. Investors prefer corporations because of the way corporate profits are taxed compared to LLC profits.

Why Corporations Attract Investors

Corporations attract investors because investors are only taxed on the distributions (dividends) they receive from the corporation.

In an LLC, the investor would be taxed on their portion (based on ownership interest) of the profits even if they didn't receive a distribution.

LLCs can also be challenging for investors when they need to transfer investment interest in the LLC. Corporate shares make this process easy.

Need Help Forming a Corporation? Check out our How to Start a Corporation guide to learn how to get started.

When to Use an LLC for a Small Business

LLCs are great for small businesses that need a simple, low-cost way to get limited liability protection. Corporations can be complex to run and maintain and unless a small business needs to attract investors, small businesses should form an LLC.

Forming an LLC is Easy. Check out our How to Form an LLC guide to get started.

Understanding Corporations

There are elements to a corporation that set it apart from other legal entities.

A corporation has:

shares and shareholders (in most instances)
a board of directors (board members)
bylaws
21% corporate tax rate or S corporation
tax options
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

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 legal documents will be executed
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
Who will file annual reports
How the corporation will issue stock
Fiduciary duties to the corporation (i.e. acting in the best interests of the corporation)
What constitutes a quorum for voting purposes
How the day to day operations of the corporation will be conducted

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.

Corporate Taxes

A corporation pays taxes based on the current federal corporate tax rate of 21%. The owner of a corporation must pay tax on any dividends they receive.

Double Taxation

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".

Most small business owner's choose to Form an LLC because of more favorable taxation.

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.

A corporation can choose to be taxed as a standard C corporation (C corp) or as an S corporation (S corp).

Types of Corporations - Tax Options

There are three main types of corporations. Each type is taxed differently.

A nonprofit corporation is a not for profit entity that is registered at the state level as a nonprofit corporation. The nonprofit corporation can register for tax-exempt status with the IRS as a 503(c).

A C corp is a corporation that is taxed as a default corporation with the IRS. This type of corporation is currently taxed at 21% on profit. Dividends paid to shareholders are also taxed.

A corporation can elect to be taxed as an S corp. An S corp tax model allows the business owner to avoid double-taxation but also negates the investor benefits offered by corporations. It's best to elect S corp status as an LLC.

Corporate Law

A corporation is a legal entity that protects a business owner's personal assets from the corporation's debts, creditors of a corporation, and from lawsuits brought against the corporation.

Corporate law dictates the formation, funding, dissolution, and governance and operations of a corporation. Corporations are governed by both federal laws and state laws.

The U.S. Securities and Exchange Commission (SEC) also governs corporations and acts to protect investors, maintain fair markets, and support capital formation.

How to Start a Corporation

Forming and running a corporation is more complicated than forming an LLC, partnership, or sole proprietorship. We recommend hiring a formation service to help with the process.

Northwest offers affordable corporation formation services.

You can form a corporation yourself by creating an initial board of directors, filing the articles of incorporation, and choosing a registered agent. Choose your state to get started: