There are many definitions of what a corporation is. Some call it an “artificial entity,” enjoying certain legal functions, rights and duties. Being an artificial or fictitious person, it can only act through its directors, who are elected by the shareholders, and its officers, who are appointed by the directors. For more information see Shareholders, Directors and Officers.
Advantages of a Corporation
A corporation may be formed for a wide variety of purposes, both profit or non-profit. Shareholders have limited liability in most cases. This limited liability is not absolute and a corporate shareholder can still be liable for the full price of his corporate stock if the stock was purchased at a discount. Shareholders are also liable, in most states, for
Ownership of corporate stock may be transferred freely by sale or by gift. The corporation has perpetual existence that remains unaffected by the death of any director, officer, or shareholder. The corporation, as a legal person, can sue and be sued, make contracts, hold both real and personal property, and issue stock.
A corporation also has flexibility in choosing the securities (stocks, notes, or bonds) it may issue in raising capital.
Finally, a corporation can elect the advantage of being an S corporation and the use of Section 1244 stock. Internal Revenue Code Section 1244 was enacted in an attempt to attract financing for small businesses. Under this an individual is allowed to deduct, as ordinary loss, a loss on the sale or exchange of certain stock owned in a “small
business.” This provision allows individuals to deduct up to $50,000 annually (if filing as a single taxpayer) or $100,000 (for those people filing joint).
If the corporation prospers, its owners are generally permitted to transfer interests, in the form of the corporation’s stock, to their children. Such transfer cannot be done directly in a sole proprietorship, and only with the consent of all the partners if a partnership.
Disadvantages of a Corporation
There are several disadvantages inherent in the formation of a corporation. The limited liability of a shareholder might limit the amount of credit that the corporation might be able to obtain. If the corporation has few shareholders, the majority shareholders have the ability to make decisions that may not be in the best interest of the minority shareholders. If the corporation is publicly traded, voting rights might prove insignificant due to the widespread ownership. Management of a corporation is in the hands of the directors and therefore separate from the shareholders
who are the true owners of the corporation. A corporation is subject to the laws of any state in which it does business.
In addition a corporation is not protected by the Fifth Amendment’s guarantee against self-incrimination. This privilege is deemed purely a personal one available only individuals. Corporations are subject to greater governmental
control than other forms of doing business. Finally, corporate shareholders are subject to double taxation, one at the corporate level (as high as 35%) and the other at the individual level. Double taxation can be avoided by the election of S corporation status.
See the comparison between the corporation and partnership forms and the the corporation and the LLC forms with respect to the factors that will be most important.
Also, see the “So, you want to incorporate…?.