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Updated for 2011

Business Structures

What Is a Corporation?

A corporation is created under state law. It is a separate legal entity, separate and apart from its owners (called shareholders). This applies to both C and S corporations. The C and S simply refer to the Internal Revenue Code (IRC) sections governing their tax treatment.

Observation:

Keep in mind, all corporations start their corporate existence as C corporations.

After the initial incorporation, shareholders are then free to apply to the IRS for S corporation tax treatment. From 2553 is used for this purpose (this was the latest form as of Jan. 17, 2012).

An S corporation is a pass-through entity. This means, all income, deductions, gains, losses, and credits pass through the company to its shareholders who report these items on their individual income tax returns via Schedule E. Part II.

S corporation shareholders receive Schedule K-1 (instructions) annually, which reports their share of the above items.

A C corporation is not a pass-through entity. The corporation reports its own profits and losses and pays its own taxes.

C corporation profits are distributed as dividends to its shareholders. If profits are not distributed, they are credited to "Retained Earnings" (shown in the stockholders' equity section of the balance sheet).

Ten Legal Attributes of a Corporation

Although C and S corporations are treated differently for tax purposes, legally, they are treated the same. In other words, the laws of the state of incorporation apply whether you remain a C corporations or elect to change to an S corporation. Changing to S status is simply a tax election and has nothing to do with the legal status of the corporation.

The following legal attributes apply to a corporation (C or S corporation):

  1. It is a separate legal entity, separate and apart from its owner(s) (shareholder(s)).
    • In a widely quoted definition, Chief Justice John Marshall in 1819 described a corporation as "an artificial being, invisible, intangible, and existing only in the contemplation of the law."
  2. It provides shareholders limited liability from corporate debts.
    • This is one of the most important reasons for incorporating.
  3. It is formed under state or federal law or the laws of other countries.
    • A corporate charter is obtained from one of the fifty states.
  4. Shares of stock may be transferred freely provided there are no restrictions.
  5. It has continuity of life.
    • If a shareholder dies or sells his/her shares, the corporation continues doing business as usual.
  6. It can buy, sell, and own property in its own name.
  7. It can enter into contracts with others.
  8. It can sue and be sued in its own name.
  9. It can be a partner in another business.
  10. Its name is signed by corporate seal.

Tax Identification Numbers For a Corporation

Employer Identification Number (EIN):

A corporation must have an EIN. The IRS issues it. The number is used to identify the corporation on tax documents.

State Withholding Number:

For state purposes, the corporation will need a state withholding number. Some states, such as Nevada, don't have a personal income tax. Check your state.

State Account Number:

This is for state unemployment tax (SUTA) reporting. Generally, states, such as Arizona, assign each employer an account number. Check your state.

Note: Learn about exchanging property for stock in a corporation, tax-free.

Next:

C-corporations: Protecting Your Personal Assets; Lawsuits and Tax Audits; The Corporate Records Book

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