C-Corporation Stock

The corporate form has become common method for many business organizations. Its separate entity legal standing provides substantial degree of financial protection for its investors. Prior to the creation of the corporate form of business organization, investors in a business were liable for all of the debts the organization. If the business lost money and didn't have the cash to pay its creditors, the partners had to make up the difference with their own money. Corporations now shield the investor from unlimited downside risk. The corporate form created an environment in which more people were willing to invest in business ventures.

A corporation is a separate and distinct legal entity. Corporations can open bank accounts, own property and do business, all under its own name. The primary advantage of a corporation is that its owners, known as stockholders or shareholders, are not personally liable for the debts and liabilities of the corporation. If a corporation gets sued and is forced into bankruptcy, the maximum risk to the investor is the loss of his/her investment. The owners will not be required to pay the debts of the firm with their own money. If, upon liquidation of the assets, the corporation still cannot pay all of its obligations, creditors cannot legally collect what is due to them from the shareholders, directors or officers of the corporation to recover any shortfall unless the debt was personally guaranteed by shareholder, director or officer or fraud is proven.

Recent events involving accounting practices that created false perceptions of revenues and profits that were attributed to officers of some of worlds largest organizations illustrate the fact that their is no absolute protection for decision makers through the corporate shield. Owners of small business corporations often find themselves having to personally guarantee a bank loan for the firm as a condition of the loan agreement.

INC - Advantages & Disadvantages

There are many advantages corporations have over partnerships and sole proprietorships. But there are also disadvantages. We will examine some of the most important upsides and downsides below.

Advantages:

Stockholders are not liable for corporate debts:
This is the most important aspect of a corporation. In a sole proprietorship and partnership, the owners are personally responsible for the debts of the business. If the assets of the sole proprietorship or partnership cannot satisfy the debt, creditors can go after each owner's personal bank account, house, etc. to make up the difference. On the other hand, if a corporation runs out of funds, its owners are usually off the hook.
Please note that under certain circumstances, an individual stockholder may be liable for corporate debts. This is sometimes referred to as "piercing the corporate veil." Some of these circumstances include:

If a stockholder personally guarantees a debt.
If personal funds are intermingled with corporate funds.
If a corporation fails to have director and shareholder meetings.
If the corporation has minimal capitalization or minimal insurance.
If the corporation fails to pay state taxes or otherwise violates state law.

Self-Employment Tax Savings:
Net income derived from a sole proprietorship is is treated as if it were wages and are subject to self-employment taxes, which are currently a combined 15.3%. The reason behind this is that the employer and the employee are one in the same. To illustrate this point, if we assume that sole proprietor hires a person other them him/herself, that person is treated as an employee. The employer in any type of organization will withhold payroll taxes from the employee of 7.65%. These payroll taxes are also known as FICA and medicare. The employer will also pay an equivalent amount of 7.65%. The total amount of employer and employee payroll tax collected will equal 15.3%. Because the sole proprietor is also treated as an employee, the sole proprietor shoulders both payroll tax burdens. With a corporation, only salaries are subject to such taxes; profits are not treated as wages income. This advantage is most significant for stockholder-employees who take a salary of less than $72,600.
Example: If a sole proprietorship earns $50,000, a 15.3% tax would have to be paid on the entire $50,000. If a similar organization was a corporation and also earns $50,000, but $30,000 of that amount is paid in salary, and $20,000 is classified as profits, the self-employment tax would not be paid on the $20,000 profit. This saves the stockholder-employee over $3,000 per year. Beware, it is not prudent to attempt to save money by paying yourself and unreasonably low salary to avoid payroll taxes. The IRS knows what is a reasonable range and such tactics may improve your chances of a time and money wasting tax audit.

Corporations can live forever:
Well it almost seems like it. Unlike a partnership or sole proprietorship, corporations are not forced to dissolve upon the death of its stockholders, directors or officers.

More ways to raise money:
Corporations have additional ways to raise needed capital. In addition to debt which is available to all organizational structure the corporation can sell shares of stock. It can create new types of stock, such as preferred stock, with different voting or profit characteristics.

Transferability is easier:
Ownership interests in a corporation may be sold to third parties without disturbing the continued operation of the business. The business of a sole proprietorship or partnership, on the other hand, cannot be sold whole; instead, each of its assets, licenses and permits must be individually transferred, and new bank accounts and tax identification numbers are required.
A corporation's stockholders may freely sell or transfer shares to anyone. However, with small corporations in which the stockholders act more like partners and each is integral to the success of the company, they may wish to consider placing restrictions on the transfer of shares.
Stockholders sometimes enter into a buy-sell agreement which gives the terms for when shares can be transferred or sold. A typical buy-sell agreement would state that if one stockholder seeks to sell shares to any third party, the other stockholders have a right of first refusal; that is, the other stockholders may purchase those shares at the same price. Only if the other stockholders do not purchase those shares can a stockholder sell to a third party.

Disadvantages

Higher costs:
Corporations cost more to set up and run than a sole proprietorship or partnership. A corporation is created only after legal documents have been filed with and approved by the state. Higher costs arise because there are the initial formation fees, filing fees and annual state fees.
Furthermore, a corporation must follow a variety of technical formalities. These include holding director and shareholder meetings, recording minutes, having the board of directors approve major business transactions and corporate record-keeping. If these formalities are not kept, the stockholders risk losing their personal liability protection. While keeping corporate formalities is not difficult, it can be time-consuming and may add costs to the business entity. Conversely, sole proprietors or partnerships can begin operations without any formal organizing or operating procedures.

Unemployment tax:
A stockholder-employee of a corporation is required to pay unemployment insurance taxes on his or her salary, whereas a sole proprietor or partner is not. The current federal unemployment tax is 6.2% of the first $7,000 of wages paid, with a maximum of $434 per employee.

Corporate Management Structure

Corporations are managed by a board of directors The directors are responsible for making major business decisions and providing oversight of the hired management team. In smaller corporations the directors are the owner/management team. No matter the size of the organization, oversight of the corporation is the prime responsibility of the board of directors. Often board members are external to the organization meaning that they may be neither a shareholder nor employee of the firm. External board members may provide invaluable objective advice because they bring to the board fresh perspectives and management skills.

Directors are elected by the stockholders of the corporation. Officers are employees of the firm who run the day-to-day operations of the corporation, and are appointed by the directors.

Corporations are required to hold at least one annual meeting of shareholders to elect directors. The minutes of these meetings must be carefully maintained by the corporation. If the corporation has only one or a few stockholders, it may make sense to hold the meetings by conference call, or simply by having the stockholders sign a statement indicating what actions are approved.

The Board of Directors

A corporation is managed by the board of directors, which must approve major business decisions. The articles of incorporation or its bylaws will determine how many directors will be elected and what shall constitute a quorum for a valid vote to be taken on an issue. Directors may, but are not required to be, either a shareholder or an officer. Directors are elected by the shareholders and typically serve for a limited term. Corporations must have at least one director.

Examples of procedures which must be approved by the board of directors include:

Declaring a dividend,
Electing officers and setting the terms of their employment,
Amending bylaws or the articles of incorporation,
Any corporate merger, reorganization or other significant corporate transaction.

Directors of a corporation have a fiduciary duty to the corporation. They are legally obligated to act with loyalty and care to the corporation. Generally, means that directors must act in good faith, prudently, and in the best interest of the corporation.

Officers:

Officers are appointed by the board of directors to run the day-to-day operations of the corporation. A corporation must have at least three officers: (1) a president, (2) a treasurer or chief financial officer and (3) a secretary. Officers do not have to be stockholders or directors, but they can be. There is no limit on the maximum number of officers, and no limit on the number of offices that a person may hold. It is possible the same person may hold all offices.

Officer compensation is determined by the directors and many boards include company stock as part of the executive compensation package. Stock options that accrue at certain periods of time (vesting) help to create an incentive among hired officers to maximize long profitability rather than focusing only on immediate returns. Directors understand that tying pay to long term performance reduces the chance of overly risky operational maneuvers by officers to make their annual performance numbers "look good" by creating long term detrimental effects because of their decisions.

Stockholders are the ultimate owners of a corporation. They have the right to elect directors, vote on major corporate actions (such as mergers) and share in the profits of the corporation. However, stockholders do not have the right to direct the day-to-day operations of the corporation.

Tax Issues Affecting Corporations

The primary disadvantage of a traditional corporation is double taxation. A traditional corporation, known as a "C-corporation," pays a corporate tax on its corporate income (the first tax). Then, when the C-corporation distributes profits to its stockholders, the stockholders pay income tax on those dividends (the second tax).

To avoid double taxation, corporations can make a special election to be taxed as a pass-through entity, like a partnership or a sole proprietorship. In other words, there is only one level of taxation. The corporate profits "pass through" to the owners, who pay taxes on the profits at their individual tax rates. Corporations that make this tax election are known as "S-corporations." Corporations that elect the S-corporation status are usually small closely held firms with no plans for seeking large amounts of equity capital.

Some states also have a state corporate income tax. Corporations that anticipate a tax liability of $500 or more must estimate their taxes and make quarterly estimated tax payments. Corporations with employees are required to pay federal (and sometimes state) payroll taxes.

Ownership restrictions for S-corporations:

S-corporations cannot have more than 75 stockholders, and each stockholder must be an individual who is a resident or citizen of the United States. Also, it is difficult to place shares of an S-corporation into a living trust.

INC vs. Proprietorship, Partnership & LLC

Limited liability companies are a type of business entity that combines the personal liability protection of a corporation with the tax benefits and simplicity of a partnership. In addition, there are other important differences between corporations and LLC's. The following discusses the main advantages and disadvantages of corporations versus LLCs.

Advantages of Corporations:

Profits are not subject to social security and medicare taxes.
Salaries and profits of an LLC are subject to self-employment taxes, currently equal to a combined 15.3%. With a corporation, only salaries, and not profits, are subject to such taxes. This advantage is most significant for stockholder-owners who take a salary of less than $72,600.
Example:
If a sole proprietorship earns $50,000, a 15.3% tax would have to be paid on the entire $50,000. If a similar organization was a corporation and also earns $50,000, but $30,000 of that amount is paid in salary, and $20,000 is classified as profits, the self-employment tax would not be paid on the $20,000 profit. This saves the stockholder-employee over $3,000 per year. The IRS knows what is a reasonable range and such tactics may improve your chances of a time and money wasting tax audit. In situations where the IRS feels that shareholders are taking too little in salary, the IRS will characterize all or part of the profits as salary.

There is a greater understanding of the corporate form.
Because limited liability companies are still relatively new, not everyone is familiar with them. In some cases, banks or vendors may be reluctant to extend credit to limited liability companies. Moreover, there are restrictions as to the type of business that an LLC may conduct in some states.

More variety and fewer taxes on fringe benefits.
Corporations can offer a wider variety of fringe benefit plans than any other type of business entity. An array of retirement, stock option and employee stock purchase plans are available only for corporations. Plus, while sole proprietors, partners and employees owning more than 2% of an S-corporation must pay taxes on fringe benefits (such as group-term life insurance, medical reimbursement plans, medical insurance premiums and parking), stockholder-employees of a C-corporation do not have to pay taxes on these benefits.

Tax Flexibility:
While C-corporations are subject to double taxation, they also offer greater tax flexibility. A C-corporation does not have to immediately distribute its profits to shareholders as a dividend.

Disadvantages of Corporations versus LLC's

Corporations must hold regular meetings of the board of directors and shareholders and keep written corporate minutes.
Members and managers of an LLC need not hold regular meetings, which reduces complications and paperwork.
Ownership restrictions for S-corporations.

S-corporations cannot have more than 75 stockholders. And, each stockholder must be an individual who is a resident or citizen of the United States. Also, it is difficult to place shares of an S-corporation into a living trust. None of these restrictions or difficulties apply to an LLC.

Shareholders of C-corporations cannot deduct operating losses.
Members who are active participants in the business of an LLC are able to deduct operating losses of the LLC against their regular income to the extent permitted by law. Shareholders of an S-corporation are also able to deduct operating losses, but not shareholders of a C-corporation.

The Incorporation Process

The life of a corporation begins upon the filing of articles of incorporation with the secretary of state's office. Before filing the articles of incorporation, you may wish to consider the state in which you plan to create the corporation.

Choose a Location

You can incorporate in any of the 50 states. Despite the state's size, there are many Delaware corporations. Delaware is often chosen because Delaware offers some significant advantages relative to most other states. Over half of the companies listed on the New York Stock Exchange are incorporated in Delaware. Nevada is also popular due to its pro-business environment and lack of a formal information-sharing agreement with the IRS. Neither Delaware nor Nevada have corporate income taxes, and business filings in these states can usually be performed more quickly than in other states.

Many people still choose to incorporate in their home state. Doing so may save you money because corporations are required to register as a "foreign corporation" in each state where they do business, and there is often no need to pay another person to serve as the registered agent. For example, a Delaware corporation that has its main business office in Texas must register as a "foreign corporation" with the Texas Secretary of State.

If your home state has a high corporate income tax or high state fee, and your corporation will not "do business" in the home state, it may be wise to incorporate elsewhere. "Doing business" means more than just selling products or making passive investments in that state. It usually requires occupying an office or otherwise having an active business presence.

Tax forms and licenses

Every corporation must obtain a federal tax identification number, which is similar to an individual's social security number. Some states also require a separate state tax number. In addition, county and city business licenses may be required. Check with your city and county to see which types of licenses you need.

Choosing a name

In general, the name of a corporation must end with "incorporated," "corporation," "corp" or "Inc." A name will not be accepted if it is likely to mislead the public or if it too closely resembles the name of another corporation formed in that state.
You may wish to secure federal trademark protection for your name. Your name can become synonymous with your "brand", and brand recognition adds value to your firm. What do you suppose the name Coca Cola is worth? Federal trademark protection for your name protects you from others trying to capitalize on your "good name" by ensuring that no one else in the U.S. may use that name in connection with the same general type of goods or services (except in areas where someone else is already using that name).

Registered Agent

Every corporation must have a registered agent. The resident agent is an individual designated to receive official state correspondence and notice if the corporation is "served" with a lawsuit. The registered agent must be either (1) an adult living in the state of formation with a street address (P.O. boxes are not acceptable) or (2) a corporation with a business office in the state of formation which provides registered agent services.
One of the advantages of forming a corporation in your home state is that any officer or director can act as the registered agent. However, there are some advantages to having a third party represent your firm as its registered agent. First, an extra layer of privacy is added, because the name and address of the registered agent is publicly available. Additionally, if your corporation is named in a lawsuit, no one will surprise you at home with court papers.

Types of Stock

Stock Shares and Values

The articles of incorporation must state the maximum number of stock shares that can be issued by the corporation. You are not required to actually issue the maximum number of shares. You may choose to issue fewer shares than the maximum number allowed. Issuing fewer shares provides some flexibility should you wish to bring in other investors. Otherwise, if additional shares were needed, the articles of incorporation would have to be amended. There is no maximum on the number of shares that can be authorized, but be advised that some states base their annual corporation fee on the number of shares authorized.

In some states the "par value" must be stated. This value is simply for accounting and tax purposes, since stock can be sold at whatever price a buyer is willing to pay. The issuing corporation may not sell stock for less than its par value. Because some states base their annual corporation fee on the total par value of the stock, it is advisable to choose a low par value, such as $.01 or even $.001.

The Sale of Stock

The sale of stock is subject to federal and state securities laws. Generally though, if you are not advertising the sale and are dealing only with a small number (less than 35) of knowledgeable and sophisticated investors or people you know personally, then you will be exempt from the regulations. If, however, you are seeking to raise a significant amount of money from a large number of investors, you should consult with an attorney.

Types of stock and other securities issued by corporations

The most basic level of stock is called "common stock." Larger more complex organizations have differing classes of common stock.
Preferred stock is a different classification of stock and generally has greater rights over the common stock when it comes to receiving dividends and/or assets from the corporation (in case the corporation is liquidated). Preferred stock can also have special voting characteristics, conversion or redemption rights, and other features.

Warrants:
Convertible debentures

Steps to Take After Incorporating

Incorporating is just the first step in starting a new business. There are other federal, state and local requirements that should be considered. Below you will find a list of things to do or think about when starting a new corporation.

Establish a corporate banking account
Contact the state tax board for information about state taxes and obtaining a state tax number.
Check with the state department of consumer affairs or business licensing to obtain any required business licenses or permits.
Contact the Internal Revenue Service for information on filing your federal tax schedules.
Find out about workers' compensation if you will have employees.
Protect your trade name. Order any required notices (advertisements you have to place) of your intent to do business in the community.
Check zoning laws.
Obtain city and/or county business licenses or permits.
Get adequate business insurance or a business rider to a homeowner's policy.
Get tax information such as record-keeping requirements, guidelines for withholding taxes (if you will have employees), information on hiring independent contractors, facts on estimating taxes, forms of organization, etc.
Have business cards and stationery printed.
Get an email address.
Get your web site set up.

The United States Small Business Administration (SBA) offers additional information and resources on starting a new business. You can visit them on the internet at www.sba.gov, or you can contact your local branch office by phone.