By Jade Yeban, J.D. | Legally reviewed by Aviana Cooper, Esq. | Last reviewed May 17, 2024
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Starting a new business can be thrilling, but it also comes with a myriad of questions. From determining your business type to understanding the intricacies of federal tax, small business owners often seek answers to their most pressing queries. This article will explore some of the most frequently asked questions to guide those venturing into the world of business.
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A corporation is a distinct business entity separate from its owners. Unlike many other types of business structures, a corporation stands by itself as its own legal entity. This means that a corporation is separate, legally, from its owners and the other decision-makers. To put it in different terms, both corporate and tax laws view a corporation as its own "person" that can form contracts, incur debt, and pay its own taxes.
Because a corporation is its own legal entity, it does not dissolve if the original owners or shareholders die. Also, the owners of a corporation enjoy limited liability. This means their personal assets are shielded from the liabilities of the small business corporation.
This unique status means that the Internal Revenue Service (IRS) sees corporations as separate taxpayers. The board of directors, elected by the shareholders, makes the big decisions, while the day-to-day business operations are often managed by executives.
Limited liability is crucial for many business owners. It means that, typically, the personal assets of the shareholders are not at risk for the corporation's debts. For instance, if someone sues a corporation, only the business assets are on the line. This makes the corporation an attractive business type for those wary of personal financial risks.
The creditor cannot "reach through" the corporation to touch the personal assets of the owners of the corporation. These personal assets include bank accounts and homes. To maintain this limited liability, the owners of the corporation must ensure that the business complies with certain corporate formalities. In addition, the owners must provide adequate funding for the corporation. The owners cannot use the corporation merely as an extension of their own persona.
Yes, corporations differ significantly. Sole proprietorships are the simplest form, where the business owner and the business are one. Partnerships involve many people doing business together. General partnerships are typically liable for the business's debts. LLCs, or limited liability companies, combine some features of corporations and partnerships. They offer limited liability like corporations but often have simpler tax structures.
The way that corporations are unique and different from other business structures is in the way that the corporations pay taxes. Corporations are their own legal entities and pay taxes accordingly. The corporation calculates taxable corporate income by subtracting salaries and bonuses. Overhead and other expenses are also subtracted from its profits.
Unlike corporations, the profits from LLCs, partnerships, and sole proprietorships pass through to the owners. As such, those businesses are not separately taxed. Instead, the owners of LLCs, partnerships, and sole proprietorships are personally taxed on their own respective shares of the business profits.
Anyone conducting business activities that come with potential liabilities might benefit from incorporating. This can include product manufacturers, retail store owners, and even some service providers. Those looking to raise capital through selling shares or those planning to do business in multiple states might also opt for a corporation.
If your sole reason for forming a corporation is to gain the limited liability that comes with it, you may want to consider forming an LLC instead. However, here are some situations in which forming a small business corporation could benefit both you and your small business:
Depending upon the state that you are in, there are generally several steps that you have to take to incorporate your small business. First, you will have to file your articles of incorporation with the office in your state government that deals with corporations, which is usually part of the secretary of state's office. You will have to pay a filing fee when you file your articles of incorporation that may range from about $100 to $800.
The articles of incorporation must generally include:
Also, when you form a corporation, you must also create your corporate bylaws. This document will set out the rules that will govern how your corporation will run. It also lays out the decision-making process that your corporation will use.
You might also need to get a business license and an employer identification number (EIN) or tax ID from the IRS. If operating under a different name, register a DBA (Doing Business As) with the state. Depending on the state, there might be a franchise tax or an annual report requirement.
Lastly, before your small business corporation gets up and running, you must hold a meeting with all the directors of the corporation. At this meeting, you will issue stock to the initial owners of the corporation.
In short, yes. This is because corporations must abide by laws and rules that unincorporated businesses do not. As one example, corporations must hold annual meetings for shareholders. They should take minutes for any important decisions made. Also, corporations must file their own taxes. This means you must keep a very detailed financial record that includes a double-entry bookkeeping system.
Yes. Unlike unincorporated small businesses, small business corporation owners do not pay taxes on any business profits kept within the corporation. Instead, the owners of corporations only pay taxes on any salaries, bonuses, or dividends paid in return for their services to the business. The corporation itself must pay taxes on any profits left inside of the corporation from year to year.
You should be aware that this tax scheme does not apply to S-type corporations. An S-type corporation is one where the owners of the corporation elect to be taxed as if the business were a partnership. Under an S-type corporation, all the business profits pass through to the business owners, who will report these profits as income on their personal tax returns.
People often want to form a small business corporation due to their concerns about double taxation. This means the government taxes certain income twice: first at the corporation level and then when the owners receive the money. Only the income paid to owners as dividends undergoes double taxation. A dividend represents the corporate profit the corporation pays to its shareholders for their investment.
Double taxation typically happens when a corporation gives money to individuals not employed by the business. That's because the corporation can categorize money given to its employees as salary or bonus. They can then deduct these salaries and bonuses from the corporate tax as valid business expenses. This avoids the taxes on them, but when the corporation pays money to those not employed by it, it usually considers that money as a dividend. This leads to double taxation.
A professional corporation is a special type of corporation that only members of a certain profession can create. Professional corporations are often formed by lawyers, doctors, and other healthcare workers. Professional corporations have the advantage of providing their owners with a limited personal liability for the malpractice of their associates.
Generally speaking, securities laws are designed to protect investors from the bad acts of business owners. Securities laws provide requirements for corporations to follow before they can accept investment in exchange for shares in the company. Generally, a corporation must register the sale of stock with the Securities Exchange Commission (SEC) and the relevant state securities agency before granting any stock to the original shareholders.
However, if you have a small business corporation, you may be able to skip this registration process because of some exemption laws. As an example, the SEC does not require a corporation to register a private offering, which is a non-advertised sale of stock, to either:
Most states also have similar versions of these SEC exemptions. If you are planning on setting up a small business corporation with yourself and a few associates, you will most likely qualify for an exemption and will not have to file paperwork for your first sale of stock.
It certainly can help, but if you prefer the do-it-yourself route you can create a business corporation with FindLaw in minutes. If you want to make sure your start-up is in good standing, find a business organization attorney near you. Whether your company is a for-profit or a tax-exempt nonprofit, put the expertise of a skilled lawyer to work for you.
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