There is a lot to consider when starting your own business. One of the biggest decisions that you will make is the type of business structure that will be best for your company. For many entrepreneurs, the optimal business form is a corporation.

Corporations can be expensive to form and run, but they come with many advantages. In particular, when you form and properly govern a corporation, you are shielded from personal liability for the company’s debts and liabilities. There are also other benefits to incorporating, such as the ease of raising capital and the ability to transfer ownership easily.

Daryl Reese Law PC counsels clients in all aspects of business law. If you are considering starting a business, we can work with you to help you determine the best business structure and then guide you through the process. To learn more, give our law firm a call to schedule a consultation.

What Is a Corporation?

A corporation is a legal entity that is distinct from its owners. A corporation possesses many of the same rights as an individual, and is sometimes referred to as a “legal person.” As such, a corporation can enter into contracts, lend and borrow money, hire employees, sue and be sued, own assets, and pay taxes.

The most important characteristic of a corporation is limited liability. While a corporation can be owned by individuals or other entities, because it is a separate entity, the owners are not personally liable for the corporation’s debts or liabilities. A corporation’s shareholders do not accept responsibility for the corporation beyond the possible loss of their investment.

A corporation is created through a formal process known as incorporation. A group of shareholders share ownership of the corporation, with their percentage of ownership represented by stock shares. These owners share a common goal, which is often – but not always – to earn profits.

Corporations may be private, owned by one or more shareholders, or public. A public-traded corporation typically has thousands of shareholders. All corporations are created under the laws of the state in which they are incorporated. However, if a corporation is public, then it is subject to federal regulation through the Securities and Exchange Commission (SEC) and other entities.

There are two primary types of for-profit corporations: a C corporation (C corp) and a S corporation (S corp). These corporations get their names from the part of the Internal Revenue Code (IRC) that applies to how they are taxed. C corp is the standard or default selection. S corps have a special tax status, and must be elected when forming a corporation.

C corps and S corps share most of the same attributes, including general structure, the need for corporate formalities, the requirement to file documents with the state, and existence as a separate legal entity. The main difference between the two types of corporations is how they are taxed by the Internal Revenue Service (IRS).

C corporations are separate taxable entities. As such, a C corp must file a corporate tax return and pay taxes as a corporation. Shareholders who receive dividends must also pay income tax on these profits. For this reason, profits of C corporations are “double taxed.”

By contrast, S corporations are pass-through taxation entities. No income taxes are paid at the corporate level. Instead, the profits and losses are passed through to the shareholders (owners). Any taxes that are due on profits are paid by the shareholders.

There are advantages and disadvantages to each corporate type, but the bottom line is that they have many of the same attributes. An experienced California business law attorney can help you determine which corporate form is best for your business based on the characteristics of your company, your goals, and your plans for growth.

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Why Should I Incorporate? Top Benefits of Corporations

Most large companies are corporations. If you look around your home or office right now, most of the products and services that you use were probably produced by a corporation. The reason is simple: there are a lot of good reasons to incorporate. Below, we break down the top reasons corporations are a preferred legal form for many businesses.

Protection from Personal Liability

As noted above, a corporation is considered a separate legal entity. This legal fiction – that a corporation is distinct from its owners – is perhaps the most important reason for a company to incorporate. With few exceptions, this means that owners/shareholders are protected from personal liability for the corporation’s debts and liabilities. 

For example, consider the spate of recent lawsuits against manufacturers of talcum powder. These lawsuits typically allege that these products may contain asbestos, and have been linked with certain types of cancer. Johnson & Johnson is a primary defendant in these lawsuits, and to date has paid approximately $4 billion in settlements, verdicts, and defense costs.  Because Johnson & Johnson is a corporation, its owners are not personally responsible for these costs.

Personal liability protection does not just extend to product liability lawsuits, however. When you own a corporation, you generally cannot be held liable for its debts or its contractual obligations. As such, if your business goes under, creditors typically cannot go after your home, your car, or other personal assets.

There are exceptions to this rule of protection from personal liability.  If a corporation’s owners use the business in a fraudulent way, for an illegal reason, or without separation between the company and themselves, then creditors may be able to “pierce the corporate veil.” This is rare, but something that corporations should be aware of when running the business.

Increased Access to Capital

Corporations have an advantage over other types of business entities when it comes to raising capital. A corporation – particularly a public corporation – can easily raise funds by selling stock or seeking investors. This can help a corporation grow, and may also save a business during times of financial difficulties.

With a corporation, it is possible to leverage the value of a business to raise capital. Shareholders can retain control by holding onto the majority of shares while raising capital by selling off other shares. Investors are often more willing to put their money into a business when there is a possibility of partial ownership. This gives stock both an immediate and a potential value. In fact, many private equity firms will only invest in a company if they can obtain stock in exchange. This option is not available to businesses that are not incorporated.

A corporation also tends to have some level of inherent credibility, which can make it easier to obtain money from banks and other lenders. In fact, many banks prefer to lend money to corporations rather than LLCs and other types of businesses. This is another potential avenue for getting access to necessary capital.

Transferability of Ownership

Corporate ownership can also be transferred with relative ease, although there are some restrictions on ownership transfer with S corps. Other business forms – such as a sole proprietorship – do not have a “life” separate from its owner, and cannot be transferred to a third party. With a corporation, ownership can be transferred by an exchange of stock for assets.

Potential Tax Benefits

As discussed above, C corporations are taxed twice – but there are still tax benefits to running a corporation. For C corps, the net income of the business is taxed at the corporate level. C corps currently are taxed at a rate of 21%, as opposed to the highest individual tax rate of 37%. Any after-tax profits in the form of dividends are taxed to the shareholders at a favorable capital gain rate.

S corporations are not double taxed. While the shareholders’ individual tax rates may be higher than the 21% corporate tax rate, they can typically withdraw after-tax profits without paying additional taxes – avoiding double taxation.

Corporations also do not pay self-employment tax. Shareholders who are also employees pay their share of FICA taxes, while the company pays the other half. Without incorporating, these shareholder-employees would be liable for full amount of self-employment taxes.

There are also opportunities for owners to shield income from taxes through healthcare plans, life insurance, 401(k) and other retirement plans, and charitable contributions. At the same time, the corporation can deduct benefits paid to employees. The corporation can also deduct expenses, including start-up costs, legal fees, and capital expenses.

Finally, C corporations have the option of spreading out their losses over time. By carrying losses forward over a period of time, a corporation can lower its taxes for each year over which the losses are spread.

Perpetual Life

A corporation is a separate legal entity. Unlike other corporate forms, its existence does not depend on the survival of its owners. As such, the business can continue far beyond the lifetime of its owners and into future generations.

Is a Corporation the Right Form for Every Business?

While there are a lot of potential benefits to incorporation, it is not the right choice for every business. Forming and running a corporation can be expensive, and for some businesses, the costs are not worth the benefits.

First, incorporating can be a lengthy, costly process. While filing articles of incorporation with the state is relatively simple, there is a lot of paperwork involved in setting up the corporation itself and deciding how it will be run. At a minimum, you will need to draft and maintain corporate bylaws, appoint a board of directors, create a shareholders ownership change agreement, issue stock certificates, and take minutes during meetings.

Second, corporations must adhere to formalities, protocols and structure. There are both state and federal regulations that govern the operation of corporations. If you fail to follow these rules, you may lose your corporate status. It may also lead to the loss of personal liability protection.

Third, some corporations will be subject to double taxation. While there are tax advantages to incorporating, paying taxes at both the corporate and individual level can be expensive. You may be able to avoid double taxation through forming a S corp, but if you fail to meet the legal requirements for this special type of corporation, the IRS may tax you as a C corp.

There are many good reasons to incorporate your business – but that doesn’t mean that it is the best option for every company. If you are considering forming a business entity in California, contact Daryl Reese Law for guidance.

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Savvy Legal Advice for California Companies

If you have a great idea for a business, you may not know where to get started. There is a lot to consider when forming a new company, from how it will be funded to the proper business entity. Our law firm can help streamline the process for you.

Based in Santa Rosa, Daryl Reese Law PC offers skilled legal counsel to businesses throughout California. We’ll work with you to choose a corporate structure that will help your business flourish. To schedule a consultation with a California business formation lawyer, give us a call at (707) 858-5000 or fill out our online contact form

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