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Demystifying Corporations: A Beginner’s Guide to Formation

Last updated 04/01/2024 by

SuperMoney Team

Edited by

Fact checked by

Summary:
A corporation is a legal entity that is separate from its owners, known as shareholders. It can own property, enter into contracts, and engage in business activities, among other things. Forming a corporation can provide liability protection for owners and tax benefits, but it requires following certain legal and regulatory requirements.
Furthermore, we will provide an overview of what a corporation is, the different types of corporations, the steps involved in forming a corporation, legal and tax implications of corporations, and frequently asked questions.

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What is a Corporation?

A corporation is a type of legal entity that is separate from its owners. It is created by filing certain documents with the state in which it is formed, and it is regulated by state and federal laws. A corporation can own property, enter into contracts, and engage in business activities, among other things. The owners of a corporation are known as shareholders, and they are typically not personally liable for the debts and obligations of the corporation. Instead, the corporation is responsible for its own debts and obligations.

Types of Corporations

There are several different types of corporations, each with its own benefits and drawbacks. The most common types of corporations are C Corporations, S Corporations, and Limited Liability Companies (LLCs).

C Corporations

C Corporations are the most common type of corporation. They are owned by shareholders and managed by a board of directors. One of the main benefits of a C Corporation is that it provides liability protection for the owners, meaning that the shareholders are not personally liable for the debts and obligations of the corporation. C Corporations also have the ability to issue multiple classes of stock, which can be used to raise capital. However, C Corporations are subject to double taxation, meaning that the corporation is taxed on its profits, and then the shareholders are taxed again on any dividends they receive.

S Corporations

S Corporations are similar to C Corporations in many ways, but they have certain tax benefits. Like C Corporations, they provide liability protection for owners and the ability to issue stock. However, S Corporations are pass-through entities, meaning that the profits and losses of the corporation are passed through to the shareholders and are only taxed once. This can result in a lower overall tax liability for the corporation and its owners. However, S Corporations are subject to certain restrictions, such as a limit on the number of shareholders and restrictions on the types of shareholders that can own stock.

Limited Liability Companies (LLCs)

LLCs are a hybrid between a corporation and a partnership. They provide liability protection for owners, meaning that the owners are not personally liable for the debts and obligations of the LLC. Like S Corporations, LLCs are pass-through entities, meaning that the profits and losses of the LLC are passed through to the owners and are only taxed once. LLCs are also flexible in terms of management and ownership structure, and they do not have the same formalities and record-keeping requirements as corporations. However, LLCs are not able to issue stock, and they may have limited options for raising capital.

Other Types of Corporations

There are also other less common types of corporations, such as B Corporations and Benefit Corporations. B Corporations are for-profit corporations that have a stated social or environmental mission, and they are certified by a third-party organization. Benefit Corporations are similar to B Corporations in that they have a social or environmental mission, but they are legally recognized as a separate type of corporation in some states. These types of corporations may be of interest to owners who prioritize social and environmental responsibility in addition to financial gain.

Steps to Forming a Corporation

Now that we have discussed what a corporation is and the different types of corporations, let’s talk about the steps to forming a corporation.

Choose a state of incorporation

The first step to forming a corporation is to choose the state in which you want to incorporate. This decision will depend on various factors, such as tax laws, business climate, and filing fees. Many businesses choose to incorporate in Delaware, as it has a favorable business climate and well-established corporate laws.

Choose a name

Once you have chosen a state of incorporation, you will need to choose a name for your corporation. The name must be unique and not already in use by another corporation in the state. You can check the availability of a name by searching the Secretary of State’s database.

File articles of incorporation

The next step is to file Articles of Incorporation with the Secretary of State’s office in the state of incorporation. The Articles of Incorporation typically include the name of the corporation, the purpose of the corporation, the number and type of shares of stock, and the names and addresses of the initial directors.

Obtain a business license

Most states require corporations to obtain a business license before they can begin operating. The requirements for a business license vary by state and by industry.

Draft corporate bylaws

Corporate bylaws are the rules that govern the internal operations of the corporation. The bylaws typically include provisions for shareholder meetings, the election of directors, and the issuance and transfer of stock.

Hold initial board meeting

After the corporation is formed, the initial board of directors should hold a meeting to adopt the bylaws, elect officers, and approve the issuance of stock.

Issue stock certificates

Once the board of directors has approved the issuance of stock, the corporation should issue stock certificates to the shareholders.

Obtain necessary permits and licenses

Depending on the nature of your business, you may need to obtain additional permits and licenses from federal, state, or local authorities.

File annual reports and pay taxes

Corporations are required to file annual reports with the Secretary of State’s office and pay state and federal taxes.
Forming a corporation can be a complex process, and it is important to follow all the necessary steps to ensure that your corporation is legally established and protected. Consulting with an attorney or accountant can be helpful in navigating the process and avoiding potential pitfalls.

Liquidating a corporation

While most corporations operate successfully for many years, there may come a time when a corporation needs to be liquidated, either voluntarily or involuntarily. In this section, we will discuss the process of liquidating a corporation.

Voluntary Liquidation

In a voluntary liquidation, the corporation’s board of directors and shareholders decide to liquidate the corporation and wind up its affairs. The first step in a voluntary liquidation is for the board of directors to adopt a resolution authorizing the liquidation and appointing a liquidator to oversee the process.
The liquidator is responsible for selling the corporation’s assets, paying off its debts and liabilities, and distributing any remaining assets to the shareholders. The liquidator must also file the necessary paperwork with the Secretary of State’s office to dissolve the corporation.

Involuntary Liquidation

In an involuntary liquidation, the corporation is liquidated by court order. This can happen if the corporation is unable to pay its debts, has engaged in fraudulent or illegal activities, or has violated other laws or regulations.
In an involuntary liquidation, a receiver is appointed by the court to oversee the liquidation process. The receiver is responsible for selling the corporation’s assets, paying off its debts and liabilities, and distributing any remaining assets to the shareholders. The receiver must also file the necessary paperwork with the Secretary of State’s office to dissolve the corporation.

Effects of Liquidation

Once a corporation is liquidated and dissolved, it no longer exists as a legal entity. Its assets and liabilities are distributed to its shareholders, and any remaining debts or obligations are extinguished.
It is important to note that liquidating a corporation can have significant tax implications for both the corporation and its shareholders. Consulting with a tax professional or accountant is recommended to ensure that the liquidation is structured in a tax-efficient manner.
While liquidating a corporation is not a pleasant task, it is sometimes necessary to wind up the affairs of a corporation that can no longer operate successfully. By following the necessary steps and complying with legal and regulatory requirements, a corporation can be liquidated in an orderly and efficient manner.

Frequently Asked Questions

What is a corporation?

A corporation is a legal entity that is separate from its owners. It can enter into contracts, own property, and conduct business in its own name.

What are the benefits of forming a corporation?

There are several benefits to forming a corporation, including limited liability for the owners, the ability to raise capital by issuing stock, and the potential for tax benefits.

What are the different types of corporations?

The main types of corporations include C corporations, S corporations, and limited liability companies (LLCs).

How do I form a corporation?

To form a corporation, you will need to choose a state of incorporation, choose a name, file Articles of Incorporation, obtain a business license, draft corporate bylaws, issue stock certificates, and obtain necessary permits and licenses.

What are the legal and regulatory requirements for a corporation?

Corporations are subject to various legal and regulatory requirements, such as filing annual reports, paying taxes, and complying with labor and environmental laws.

What is limited liability?

Limited liability means that the owners of a corporation are not personally liable for the debts and obligations of the corporation.

What is a board of directors?

A board of directors is a group of individuals who are elected by the shareholders of a corporation to oversee the management of the corporation and make strategic decisions.

What are bylaws?

Bylaws are the rules that govern the internal operations of a corporation, including provisions for shareholder meetings, the election of directors, and the issuance and transfer of stock.

What is a shareholder?

A shareholder is an individual or entity that owns stock in a corporation and has certain rights, such as the right to vote on major decisions and the right to receive dividends.

Do I need an attorney to form a corporation?

While it is not required to hire an attorney to form a corporation, it can be helpful in navigating the legal and regulatory requirements and avoiding potential pitfalls.

Can a corporation go bankrupt?

Yes, a corporation can go bankrupt if it is unable to pay its debts and obligations.

Can a corporation be sued?

Yes, a corporation can be sued for various reasons, such as breach of contract or negligence.

Can a corporation issue stock?

Yes, a corporation can issue stock to raise capital from investors.

Can a corporation be owned by one person?

Yes, a corporation can be owned by one person, who is referred to as a “sole shareholder.”

Key takeaways

  • A corporation is a legal entity that is separate from its owners and can enter into contracts, own property, and conduct business in its own name.
  • The benefits of forming a corporation include limited liability for the owners, the ability to raise capital by issuing stock, and the potential for tax benefits.
  • The main types of corporations include C corporations, S corporations, and limited liability companies (LLCs), each with their own advantages and disadvantages.
  • To form a corporation, you will need to choose a state of incorporation, choose a name, file Articles of Incorporation, obtain a business license, draft corporate bylaws, issue stock certificates, and obtain necessary permits and licenses.
  • Corporations are subject to various legal and regulatory requirements, such as filing annual reports, paying taxes, and complying with labor and environmental laws.
  • The day-to-day operations of a corporation are overseen by a board of directors, who are elected by the shareholders, and managed by officers appointed by the board.
  • By understanding the key concepts and steps involved in forming and operating a corporation, entrepreneurs and business owners can make informed decisions about the best structure for their business and navigate the legal and regulatory landscape with confidence.

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