Incorporation also offers business owners relief from business taxes. All corporations are legal business structures regulated by state incorporation laws, as well as by state and federal tax laws.
Under the law, an incorporated business becomes a legal entity capable of entering into contracts, incurring debts and paying taxes separately from its owners. Corporations enjoy limited liability: if a corporation gets sued, only its assets - not the personal assets of the business owners - are at risk.
Corporations also enjoy corporate tax advantages resulting in different kinds of overall tax savings (depending on the kind of corporation). For-profit corporations have the legal framework to issue ownership interests as shares of private or public stock.
Rules governing corporations require that all corporations establish a board of directors, write bylaws, hold "recorded" monthly board meetings, appoint officers, have a corporate seal, meet legal requirements for paperwork, and file Articles of Incorporation with state agencies.
Only for-profit corporations have the additional required responsibilities of separating management from owners (directors from stock-owning shareholders), maintaining a stock ledger, and holding an annual shareholder meeting.
Types of Corporations
There are different kinds of corporations available under state and federal law (and corporate laws vary only slightly from state-to-state). The different kinds of corporations a business owner can choose from include:
Regular ("C") Corporations: a for-profit corporation whose profits are taxed separately from its owners' under subchapter C of the Internal Revenue Code and whose owners enjoy limited liability. Because the first $75,000 of profits retained in a C corporation are taxed at a separate corporate income tax rate that is lower than the individual income tax rates of business owners, owners who work for their corporation can split business income between themselves, individually, and their business. Owners can use this technique, known as "income splitting," to achieve overall tax savings. C corporations also allow owners to deduct fringe benefits as a business expense.
"S" Corporations: a profit-making corporation, organized under state law, whose shareholders have applied for and received subchapter S corporation status from the Internal Revenue Service. Electing to do business as an S corporation lets shareholders enjoy limited liability status, as would be true of any corporation, but be taxed like a partnership or sole proprietor. That is, instead of being taxed as a separate entity (as would be the case with a C corporation), an S corporation is a pass-through tax entity in which income taxes are reported and paid by the shareholders, not the S corporation. In this way, owners can report their share of corporate profit or loss on their personal tax and use corporate loss to offset income from other sources. To qualify as an S corporation, a number of IRS rules must be met, such as having 75 or fewer shareholders who are U.S. citizens. (Note: aside from sole proprietorships, this is the only business entity that limits the number of owners.)
Nonprofit Corporations: a legal structure, authorized by state law, allowing people to come together to either benefit members of an organization (e.g., a club or mutual benefit society) or for some public purpose (such as a hospital, environmental organization or literary society). Nonprofit corporations, despite the name, can make a profit, but the business cannot be designed primarily for profit-making purposes, and the profits must be used for either the benefit of the organization or the purpose the corporation was created to help.
When a nonprofit corporation dissolves, any remaining assets must be distributed to another nonprofit. As with for-profit corporations, directors of nonprofit corporations are normally shielded from personal liability for the organization's debts. Some nonprofit corporations qualify for a federal tax exemption under §501(c)(3) of the Internal Revenue Code, with the result that contributions to the nonprofit are tax deductible by their donors.
Professional Corporations: a legal structure, authorized by state law, for a fairly narrow list of licensed professions, including lawyers, doctors, accountants, many types of higher-level health providers, and often architects. Unlike a regular corporation, a professional corporation does not absolve a professional for personal liability for her own negligence or malpractice. The main reason why groups of professions choose this organizational structure is that, unlike a general partnership, owners are not personally liable for the malpractice of other owners. (In some states, limited liability partnerships offer this same benefit and may be more desirable for other reasons.) Tax benefits are also available.
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