What is a Corporation?

A Corporation is a legal entity governed by state law, that exists separate and apart from those individuals who created it.  It is an invaluable asset protection tool because it shields all of its participants from liability for the debts of the business. Properly structured, a corporation can provide the maximum protection against liability from third parties while offering the most attractive tax benefits to the owners of the business.

Advantages

  • Limited Liability – investors risk only the amount of their investment and are not individually responsible for corporate obligations.  Similarly, directors, officers and employees are not personally liable for corporate obligations unless in violation of law.
  • Separate legal existence – a corporation is a legal entity separate from the people who manage and work for it, or participate in its activities-a legal “person,” capable of entering into contracts, incurring debts, receiving and maintaining funds, and, generally, doing anything a real person can do.
  • Centralized management – business is managed by a board of directors and by elected officers. The owners of the business are the shareholders, who contribute cash, property, or services in exchange for their ownership rights, evidenced by share certificates.
  • Continuity of life – a corporation has the power to exist forever and, therefore, is unaffected by the death of an owner or manager or by the transfer of ownership interests.
  • Capital generation – may sell common or preferred stock, issue bonds, and borrow money, mortgage assets, or contract for many types of financing.
  • More tax deductions and tax planning benefits available than to the unincorporated business.  Has the ability to use a different fiscal year end other than December 31, which can create awesome tax advantages.
  • Fewer IRS Audits.
  • A business can offer its owners and employees a variety of fringe benefits, which may be wholly or partially tax-free or tax-deferred.

Disadvantages

  • Double taxation. Income received by the corporation is taxed at the corporate level according to the corporate rates then in effect. The profit remaining after taxes is available for distribution to shareholders as dividends; and if dividends are distributed, the distribution is taxed again as personal income to the shareholder.

    (In the real world, small closely held corporations can easily avoid income taxes. All or almost all of the earnings are typically paid out to its employees as wages and fringe benefits. After everyone and everything is paid, there is usually no income for the corporation to owe tax upon.)

  • Securities regulation – sales of bonds, notes, stock, investment contracts, etc. to raise money requires securities registration if offered to the public and advertising or solicitation is used to attract investors.
  • Required to hold and document board of director and shareholder meetings.

Tax Implications

  • Corporations file a separate tax return (IRS Form 1120) and report earnings and taxable profit.
  • Will be liable for employment taxes.
  • To take advantage of tax-free fringe benefits the following requirements must be met:

    -The tax code must specifically allow it
    -It needs to be in writing (plan documents, director approval thru minutes/resolutions)
    -It must have an indefinite life (can’t expire next year or based on age of employee)