Corporation Basics

Personal accountability for company debts is limited by corporations, but managing them requires effort.

The majority of individuals are aware that creating a company gives "limited liability," which means that your personal culpability for corporate obligations is restricted. What you may not realize is that forming and operating a business entails more than just completing a few paperwork. To manage the more difficult corporation tax return, you'll need to keep solid records, and you'll need to follow corporate formalities like decision-making and record-keeping to keep your restricted liability. In a nutshell, you must be well-organized

What is a Corporation?

A corporation is a separate legal business entity from its owners, which means it owns property, pays taxes, and enters into contracts on its own. A corporation's ownership and management structure differs from those of other commercial organizations. A corporation's owners are shareholders (also known as stockholders), who purchase shares of stock to gain a stake in the company. Shareholders elect a board of directors, which is in charge of running the company.

Limited Personal Liability

One of the primary benefits of forming a company is that the owners' personal assets are safeguarded from the firm's creditors. For example, if a court decision declares that your business owes a creditor $100,000, you cannot be forced to pay the obligation with personal assets such as your home. Because only corporate assets may be used to pay off business obligations, you'll only lose the money you put into the company.

Exceptions to Limited Liability

Limited liability may not be enough to safeguard an owner's personal assets in particular situations. A corporation's owner may be held personally responsible if he or she:

• personally and directly injures someone
• personally guarantees a bank loan or a business debt on which the corporation defaults
• fails to deposit taxes withheld from employees' wages
• does something intentionally fraudulent or illegal that causes harm to the company or to someone else, or
• treats the corporation as an extension of his or her personal affairs, rather than as a separate legal entity.

This is the most significant exception. Courts have the power to decide that a company does not exist and that its owners should not be protected from personal accountability for their actions in certain situations. This might happen if you don't follow standard company procedures, such as:

• adequately investing money in ("capitalizing") the corporation
• formally issuing stock to the initial shareholders
• regularly holding meetings of directors and shareholders, or
• keeping business records and transactions separate from those of the owners.

Liability Insurance

Incorporation should never be used as a substitute for adequate company insurance. Although creating a company protects your personal assets, you need to insure your business assets to safeguard them from litigation and claims.

Many of the dangers that come with running a business may be mitigated with good liability insurance coverage. If you own a clothes store, for example, proper business insurance should cover the costs if someone slips and falls in your store.

In addition, insurance can protect you in situations where the limited liability option is ineffective. For example, if you personally hurt someone while conducting business for the organization, such as by causing a vehicle accident, liability insurance would typically cover the accident, allowing you to pay the bill without having to utilize corporate or personal assets. However, insurance will not assist if your company fails to pay its bills: commercial insurance does not generally cover personal or corporate assets from unpaid business obligations, regardless of whether they are personally guaranteed.

Paying Corporate Income Tax

If a corporation's owner works for the company, he or she gets a salary and potentially bonuses, just like any other employee. The owner, like normal workers, pays taxes on this income, declaring and paying the tax on his or her personal tax return.

After paying out all wages, bonuses, overhead, and other expenditures, the corporation pays taxes on whatever earnings are left in the firm. To do so, the corporation files its own tax return with the Internal Revenue Service (IRS), Form 1120, and pays taxes at a specific corporate tax rate. For companies, the Tax Cuts and Jobs Act introduced a new single flat tax rate of 21%. This replaces the previous law's business tax rates, which ranged from 15% to 35%.

Alternatively, company shareholders can file Form 2553 with the IRS to elect "S corporation" status. This implies that for tax purposes, the company will be taxed as a partnership (or LLC), with business gains and losses "passing through" to the owners' individual tax returns.

Forming a Corporation

You must file "articles of incorporation" with your state government's corporations division (typically part of the secretary of state's office) to create a corporation. The filing fee is usually around $100.

Articles of incorporation are typically brief and simple to prepare for most small businesses. Most states give you a basic form to fill out, which generally only asks for the name of your business, its address, and the contact information for one person connected with the business (often called a "registered agent"). Some states additionally require you to include the names of your corporation's directors.

You must also prepare "corporate bylaws" in addition to submitting articles of incorporation. While bylaws are not required to be filed with the state, they are significant because they establish the fundamental rules that govern the ongoing formalities and decisions of corporate life, such as how and when to hold regular and special meetings of directors and shareholders, as well as the number of votes required to approve corporate decisions.

Finally, you must give stock certificates to the corporation's first owners (shareholders) and keep track of who owns the company's ownership interests (shares or stock).

Retaining Corporate Status

To keep the corporation's position as a distinct entity, corporations and their owners must follow specific procedures. Corporations must, in particular;

• hold annual shareholders' and directors' meetings
• keep minutes of shareholders' and directors' major decisions
• make sure that corporate officers and directors sign documents in the name of the corporation
• maintain separate bank accounts from their owners
• keep detailed financial records, and
• file a separate corporate income tax return.

​Yoel Molina, Esq. (AKA “Mo”)

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