What is a corporation? In its broadest terms, a corporation is a distinct legal entity for doing business that has certain rights under the law.
What is a Corporation?
A corporation is a legal entity. Created centuries ago, it separates legal liability from legal ownership. Under a corporate structure, investors avoid liability for the actions of the managers of the business. Presumably, their beneficial purpose was to increase investment.
Because corporations are distinct legal entities, their legal treatment is unique. Although it cannot act on its own, managers and employees can act for it, and those actions belong to the company.
Unlike in an LLC, owners appoint a corporation’s manager. To do so, the shareholders vote for a board of directors. Then, the board of directors appoints a manager or managers. This separation is part of what creates the limited personal liability.
Owners of a corporation do not need to worry about their personal assets being subject to a lawsuit against the company. This “limited liability” exists in both corporations and LLCs. The only times a shareholder is personally liable is when the shareholder did something wrong, or a plaintiff can pierce the corporate veil. Fortunately, piercing the corporate veil is a very difficult thing to prove necessary.
The most important thing to remember when using a corporation is to be sure to keep everything separate. It’s a distinct legal entity, so it needs its own bank account, accounting records, and everything else. It is easiest if you pretend you are merely doing favors for this other person who cannot act on their own.
Separate entities have separate taxes. Corporations are no different. These companies must file a separate tax return each year. Some corporations are permitted to elect to be taxed as a subchapter S corporation, but those still require a separate tax return.
Common Myths About The Corporation
Here are some common myths I encounter about corporations:
- The corporate “double tax” makes it too expensive to use a corporation as a small business. Untrue. The corporate level taxation (double tax) only applies to profit the company still has at the end of a tax year. Nearly every small business I work with ends up with a Net 0 after they pay themselves, meaning there’s no corporate taxes owed.
- Corporations have more formalities than LLCs. This is a myth because the formalities are nearly identical. There isn’t yet clear law on piercing LLC veils, but what does exist suggests both entity types require roughly the same formalities.
- Corporations are for huge businesses. The choice between corporation and LLC has nothing to do with the size of your business. Both have their own advantages and disadvantages.
- It is best to form the corporation in Delaware or some obscure state. False. Unless you’re a nationwide or multinational company, it is best to form your company in the state you live in. North Carolina requires that you file in NC regardless so long as you’re doing business here. You’d end up paying two states’ annual registrations and other fees.
The corporation is a structure that has a lot of advantages and disadvantages. When it is useful it is highly advantageous. When you’re not sure what type to use, I recommend talking with a lawyer or CPA. Absent discussing with a professional, LLC is generally the safer route, but you can always adjust your formation at a later date.