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FORMING CORPORATIONS INFORMATION
Corporations are artificial beings created by operation of law, having the
right of succession and the powers, attributes, and properties expressly
authorized by law incident to its existence. A corporation can either be a C
corporation or an S corporation. The main difference though between a C
corporation and an S corporation lies in the manner they are taxed. The corporation is characterized by limited liability of its
shareholders, as well as the issuance of shares of easily transferable stock.
The corporation is an entity separate and distinct from its
owners. As a separate person, a corporation can enter into contracts, acquire
assets, incur obligations and pay taxes independently of its owners, and the
owners generally cannot be made to pay for corporate obligations beyond the
owners' original contribution. Conversely, the owners, when they incur personal
obligations or enter into personal contracts, do not affect the corporation,
since the corporation and the owners are considered by law to be separate legal
entities. The most common type of corporation is the C corporation, this
embodies the "classic" concept of corporation.
The S corporation is one which elects subchapter S tax treatment. This tax
treatment allows the corporation to avoid entity level taxation. In other
words tax liability is passed on to its shareholders, whereas in other types of
corporation, income is taxed twice, once as corporate income and again as
income for shareholders who received dividends. A corporation survives the death of a shareholder or other transfer
in ownership.
The four (4 ) attributes of a corporation:
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It is an artificial being, i.e.,
a juridical person (legal entity) capable of having rights as well as
obligations, with a personality separate and distinct from its members or
shareholders. This attribute gives rise to a fundamental principle in
corporation law, which states that: shareholders are not personally liable
for corporate obligations and cannot be held liable to third persons who
have claims against the corporation beyond their agreed contribution to the
corporate capital.
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It is created by operation of
law. Thus mere consent of the parties to form a corporation is not enough.
Before it can acquire a juridical personality, the State must first give its
consent in the form of laws or a general enabling act.
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It has the right of succession,
which means that its continued existence during the term stated in its
articles of incorporation cannot be affected by any change in the members or
shareholders, whether this change be in consequence of death, insolvency or
any other incapacity. Nor is it affected by the transfer of shares by a
shareholder to a third person.
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The corporation has the powers,
attributes and properties expressly authorized by law or incident to its
existence. Under the traditional concept, a corporation, being merely a
creature of the law, can exercise only such powers as the law may choose to
grant it, either expressly or impliedly as contrasted with the powers of a
natural person, who can do anything as long as he/she violates no law nor
rights of others.
How is a corporation taxed?
Under the
federal income tax law,
a corporation is taxed as a separate legal entity, unless the corporation
is an S corporation, which will be discussed later. The corporation is taxed on its net income,
as gross income less allowable deductions. Corporate tax rates range from
15% to 35%. Non-cash property will form part of the corporation's taxable
assets
unless the person or group of people contributing the property owns at
least 80% of the corporation. If the corporation distributes money or
other property, such as dividends, to its shareholders, the shareholders
will be taxed.
Why
some shareholders choose to form an S corporation:
-
the corporation is profitable
and distributes nearly all of its profits to the shareholders
-
the corporation incurs
substantial losses that shareholders wish to deduct from their personal
income tax returns.
An S corporation's losses are
passed on to the shareholders who can deduct those losses from their personal
income tax returns. Profits and losses are allocated based on share ownership
for tax purposes. The shareholders must include on their individual tax returns
the profits of the S corporation even if no money was distributed to them.
How to qualify as an S
corporation:
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the corporation may not have more than 75
shareholders who are individuals
-
it may issue only one class of
stock. This prevents the company from issuing inexpensive founders' stock
for key employees.
-
it generally cannot own 80% or
more of any other corporation.
-
its funds must not come from
any or all of the following: venture capital funds, corporations or
institutional investors, since all shareholders of an S corporation must be
individuals.
Piercing the veil of corporate
entity:
The court can disregard a
corporate entity, and hold its shareholders personally liable, under the
"alter ego" doctrine. The court will determine whether or not the
shareholders have committed fraud or injustice behind the corporate veil, and
examine several factors like:
-
whether the corporation is
undercapitalized given the inherent risks in the business.
-
whether corporate assets were
used for personal reasons.
-
whether corporate assets
commingled with personal assets.
-
whether corporate and personal
books were kept separate.
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whether the board of directors
or shareholders properly authorized corporate actions.
How a corporation can protect the
shareholders' limited liability:
-
secure a record of shareholder
and board authorization for corporate actions.
-
separate corporate and personal
funds.
-
keep corporate records
completely separated from personal records.
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keep personal and corporate
funds completely separated.
-
the corporation's name should
appear clearly on all contracts, so others know whom they are dealing with.
-
draw a demarcation line between
the corporation and its shareholders.
-
provide sufficient amount of
capital for future business needs in the light of the risks involved.
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