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The Corporation as a Business Entity: Types of Corporations

The Corporation as a Business Entity:  Types of Corporations

What Defines a Corporation?

A corporation is a business entity created under state law, which stands as an independent legal “person” apart from its shareholders and directors.

Accordingly, a corporation may enter into contracts, obtain loans, and pay taxes on its own behalf, and it continues to exist even after its founders or shareholders die or transfer their shares to others.
A corporation’s owners or shareholders receive the benefit of limited liability for the obligations of the corporation, and are thus ordinarily shielded from the corporation’s creditors even in the event that the corporation cannot pay its obligations.

Unless limited by state law or its own articles of incorporation, a corporation continues indefinitely. Ownership can be transferred through sale of stock, and the sale or transfer of a controlling interest in the corporation does not necessarily affect its management structure or operations.

Types of Corporation

  • Close Corporation – A “Close Corporation” or “Closely Held Corporation” is owned by a small group of shareholders, as defined by state law, usually not exceeding thirty to fifty individuals. The stock of a close corporation is not sold either on a stock exchange or “over the counter”.
  • Public Corporation – A public corporation is a corporation whose shares are publicly traded, whether on a stock exchange or “over the counter”.
  • C Corporation – A C Corporation is a standard business corporation, which pays tax under Subchapter C of the tax code.
  • S Corporation – An S Corporation is a corporation which has elected for its profits to be taxed in the manner of an unincorporated entity. Not all corporations can opt to become S Corporations.
  • Professional Corporation (PC) – A special type of corporation incorporated to perform professional services, such as the practice of law or medicine. (Historically, professionals were not permitted to incorporate. Now, many professional practices incorporate as PC’s or LLC’s.)

Limited Liability

Perhaps the biggest historic advantage of the corporate form is the extension of limited liability to the corporation’s officers, directors, and shareholders. That is to say, if a business is sued or is unable to pay its debts, the creditors can ordinarily only reach the corporation’s assets and cannot reach the assets of the shareholders. This protection against liability is referred to as the “corporate veil”. However, certain types of misconduct by a corporation or its officers may enable creditors or state tax authorities to “pierce the corporate veil” and reach the personal assets of those who engaged in the wrongful conduct. (Federal tax authorities may already bypass the corporate veil as a matter of law.) Also, individuals can be held responsible for their own negligence and misconduct, for actions intended to damage or defraud the corporation, and for corporate debts they personally guaranteed.

In recent decades, additional limited liability entities have been created, such as the limited liability company (LLC), giving business owners a greater range of choices.

Articles of Incorporation

When you wish to form a corporation, the first step is to file “articles of incorporation” with the state in which you desire to incorporate, along with the required filing fee. Most states offer approved forms for completing and submitting articles of incorporation. Typically, states require the articles to include:

  • The name of the corporation;
  • The address of the corporation;
  • The identity of the corporation’s “registered agent” (the person designated to receive service of process and certain important documents on behalf of the corporation); and possibly The names of the directors of the corporation.

Getting Started

In addition to filing articles of incorporation, every new corporation must do the following:

  • Create a set of bylaws which govern its operation;
  • Hold an initial meeting of its board of directors; and Issue stock to its shareholders.
  • Corporations are also expected to meet certain bookkeeping standards and to maintain their own bank accounts, and most businesses will benefit from consulting with an accountant in setting up appropriate accounting and record-keeping systems.

    As they get started, most corporations will benefit from formulating a buy-sell agreement, to help guide the sale or transfer of shares by the initial set of shareholders, covering such issues as how the share value will be determined if a shareholder wishes to sell his interest, and what will happen if a shareholder dies, becomes disabled, or wishes to sell shares to a third party.

    Who Does What?

    Discussion of corporations usually involves mention of shareholders, directors, and officers:

    • Shareholders – A shareholder is the owner of shares in a corporation. Depending upon the nature of the shares, a shareholder may ordinarily participate in votes to select or remove directors, to amend the corporate bylaws or articles of incorporation, to merge or reorganize the corporation, or to dissolve the corporation or liquidate its assets.
    • Directors – A corporation’s directors typically engage in action including the election of corporate officers, the issuance of stock, oversight and approval of major financial transactions, and approving compensation packages for executives and officers of the corporation. In many small corporations, most or all of the shareholders will also serve as directors.
    • Officers – The officers of a corporation oversee its daily operations and activities. Most states require that a corporation have a President (and possibly a Vice President), Secretary, and Treasurer. In simple terms, the President has authority to direct the business, the Secretary has authority over corporate records, and the Treasurer has authority over corporate finances. Most states permit a corporation to appoint one person to all three positions.

    In a small corporation, the shareholders may also serve as directors and officers.

    Annual Meetings & Reports

    Among the obligations a corporation must meet on a continuing basis, a corporation is required to hold an annual meeting, keep minutes reflecting what occurred at the meeting, and to file an annual report and fee with the state in which it is incorporated. Failure to follow these steps can cause the corporation to lapse. While it may be possible to cure the lapse by filing late reports and payments, if it is not possible the shareholders may find themselves liable for the corporation’s outstanding debts and obligations. Also, C Corporations must file annual tax returns.

    Taxation

    A C Corporation pays taxes on its corporate income, whereas the profits of an S Corporation pass through to the shareholders who report their share of the profits on their personal tax returns. Even if corporate income tax has been paid, any dividends paid by a corporation to its shareholders are also subject to taxation as income to the shareholder.

    Securities Laws

    As the number of shareholders to a corporation grow, the possibility arises that state and federal securities laws will apply to the corporation and its conduct. If shares are to be sold or distributed to more than a limited set of shareholders (usually about thirty-five shareholders), the corporation may have to register the sale with the securities authorities of the state and federal governments before it can issue the shares.

    Securities laws can also be implicated by issuance of stock options to employees. Corporations should take care to know how securities laws apply to their situation in advance of taking action which might implicate those laws.

    The Peck Law Group

    About the Author

    Attorney Steven Peck has been practicing law since 1981. A former successful business owner, Mr. Peck initially focused his legal career on business law. Within the first three years, after some colleagues and friend’s parents endured nursing home neglect and elder abuse, he continued his education to begin practicing elder law and nursing home abuse law.


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