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What Is a Corporation?
A corporation is a legal entity that is separate and distinct from its owners and is established to conduct business or trade. It files tax returns with the Internal Revenue Service (IRS).
Corporations are formed by individuals who file articles of incorporation in the state where they intend to operate. Corporations can enter into contracts, loan and borrow money, sue and be sued, hire employees, own assets, and pay taxes.
Importantly, corporations offer their owners limited liability protection. Their shareholders profit through dividends and stock appreciation, but they are not personally liable for the company’s legal or financial liabilities.
Most large businesses, such as Microsoft (MSFT) and Coca-Cola (KO), are corporations.
Key Takeaways
- Corporations possess many of the same legal rights and responsibilities as individuals.
- A corporation may be created by an individual or a group of people.
- The corporation must file articles of incorporation in the state where it intends to register and operate.
- A corporation’s managers and shareholders are not personally responsible for the company’s legal or financial liabilities.
Investopedia / Julie Bang
How a Corporation Works
A corporation is created when a business is incorporated by an individual or a group of shareholders with a common goal. Shareholders share ownership of a business, as represented by their holding of stock shares.
Corporations may return a profit to their shareholders. Some corporations, such as charities and fraternal organizations, are nonprofit. A private or closed corporation may have a single shareholder or several. Publicly traded corporations have many shareholders.
In the U.S., corporations are created and regulated by state laws. Public corporations are regulated by federal law through the Securities and Exchange Commission (SEC).
Important
For their owners, a limited liability company (LLC) and a corporation offer similar legal advantages. A primary advantage is that shareholders cannot be held personally liable for the liabilities of either entity (except under extreme circumstances of misconduct).
Forming a Corporation
These are the basic steps to take to form a corporation:
- Decide on a name. Some of the key factors in choosing the right name include memorability, relevance, and simplicity. It’s also important that the name is available. You can conduct a trademark search on your state’s database to see if it’s free or if someone’s already claimed the name.
- Name a registered agent. This person must have a physical address in the state so they can receive any legal documents necessary to run the business.
- File articles of incorporation with the state and file any registration fees.
- Establish corporate bylaws. These are rules that highlight how the corporation will be structured and run.
- Hold a board meeting and issue stock.
- Get an employer identification number (EIN) through the IRS. You need this to file taxes and open bank accounts.
Depending on the type of company, you can open bank accounts and get credit. You may also need to get licenses and permits to operate and continue running.
Advantages and Disadvantages of Forming a Corporation
Pros
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Limited liability for owners/shareholders
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Ability to raise capital by selling shares
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Some corporations get beneficial tax treatment
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Advantages when recruiting employees
Cons
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Time consuming to form and operate
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Requires complex paperwork
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Costly to form
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Some corporate entities may be double taxed
Legal Requirements of Corporations
Each state has distinct laws regarding incorporation. Most states require the owners to file articles of incorporation with the state. They can then issue stock to the company’s shareholders. The shareholders elect a board of directors in an annual meeting.
Turning a private corporation into a public corporation is complex, as the company must comply with federal laws requiring full and public disclosure of financial information to potential shareholders and the government.
Operating a Corporation
The shareholders of a corporation typically receive one vote per share and may hold an annual meeting during which they elect a board of directors.
The board hires and oversees the senior management responsible for the corporation’s day-to-day activities.
The board of directors also executes the corporation’s business plan. Although the members are not personally responsible for the corporation’s legal and financial liabilities, they owe a duty of care to the corporation and may be held responsible if they neglect this duty.
Some tax statutes also provide for the personal financial responsibility of the board of directors for a corporation’s liabilities.
Liquidating a Corporation
Incorporation can be ended using the process called liquidation. This may result from a voluntary decision to cease operations or may be forced by the financial collapse of the business.
A company appoints a liquidator who sells the corporation’s assets. The company pays off its creditors and distributes any remaining money to the shareholders.
An involuntary liquidation is triggered by the creditors of a corporation that has failed to pay its bills. If the situation cannot be resolved, it is followed by a filing for bankruptcy.
What’s the Difference Between a Corporation and a Business?
Many businesses are corporations, and vice versa. A business can choose to operate without incorporating. Or it may seek to incorporate in order to establish its existence as a legal entity separate from its owners. This means that the owners normally cannot be held responsible for the corporation’s legal and financial liabilities.
How Is a Corporation Formed?
To form a corporation in the U.S., it is necessary to file articles of incorporation with the state in which it will be registered. The details vary from state to state. In the U.K., Ireland, and Canada, corporations may use the abbreviation Ltd., which stands for “Limited,” after the company’s name. They might also appear as public limited companies (PLCs).
What Is the Difference Between a Limited Liability Company and a Corporation?
Both a limited liability company and a corporation are business structures that offer limited liability protection to their owners.
An LLC is a pass-through entity. That is, its profits and the responsibility to pay taxes on the profits are passed to the owners rather than paid by the LLC. Establishing an LLC is a relatively straightforward process. By comparison, a corporation must elect a board of directors, conduct annual meetings, and adopt bylaws.
The Bottom Line
A corporation may be formed by an individual or group with a shared goal and can be a for-profit or not-for-profit entity.
Corporations possess many of the same legal rights and responsibilities as individuals. The limited liability protection offered by a corporation means that its executives, managers, and shareholders are not personally responsible for the company’s liabilities (unless they derive from extreme misconduct).
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