Corporations: What are they and how do they work?

The word “corporation” might bring to mind a giant company, like Walmart, Apple, or AT&T. It’s true that America’s biggest businesses are corporations. But not all corporations are large. According to IRS data, there are over 6 million corporations in the United States. Over 5 million of them have less than $500,000 in assets. Creating a corporation is easy and anyone can do it.

Quick Guide: What is a corporation? | Types of corporations | How do corporations work?

What is a Corporation?

A corporation is a type of business that is legally separate from its owners. This means that corporations have many of the same legal rights as individuals. For example, they can own property and agree to contracts. The Supreme Court has said they also have the right to exercise free speech.

Corporation vs. Company

A corporation is a type of company. In the United States, there are many business types with different tax and liability implications. Business owners may pay different amounts of tax depending on which type of company they own. They may also receive different levels of protection from lawsuits if their business is sued. Corporations offer good protection from lawsuits but are less tax-friendly than other business types.

Corporation vs. Partnership

A partnership is a different type of business structure from a corporation. Unlike a corporation, a partnership is not a separate legal entity from its owners. Owners of a partnership personally agree to contracts, pay tax on the company’s profits, and are liable if the company is sued.

Corporation vs. LLC

A limited liability company (LLC) is yet another type of business structure. It is a type of business structure that combines some benefits of corporations and partnerships. It offers some protection for the owners in case the business is sued. This is where the name “limited liability” comes from. Taxes are paid directly by the owners, similar to a partnership. LLCs are easier to establish than a corporation.

Are Corporations people?

In 2010, the Supreme Court expanded the rights of corporations to spend money on elections in Citizens United v. Federal Election Commission. Mitt Romney declared “corporations are people” on the campaign trail for the 2012 presidential election. Many commentators question how many rights America should extend to corporations.

When people say “corporations are people” they probably do not mean that they are individual human beings. They usually mean one of two things:

  1. Corporations are owned and operated by people, so any laws that affect corporations also affect people. This is what Mitt Romney meant when he said “corporations are people” in a discussion about taxes. He meant that any tax on corporations was a tax on its owners.

  2. Corporations should be eligible for many of the rights that the constitution guarantees to “natural persons” (i.e. human beings). This was an argument that the Supreme Court accepted in Citizens United.

Types of Corporations

Corporations are created under state law. Each state offers different categories of business types that owners may choose to establish. For example, compare the types of business available in California to those available in South Carolina.

Corporations also fall into the following categories created by federal IRS rules.

S-Corporation

S-Corporations are a tax-friendly alternative to C-Corporations available to businesses with few owners.

The main benefit of S-Corporations is that they are not subject to “double taxation.” Instead, each owner is responsible for paying personal income tax on their portion of the business income. No extra tax is due for distributing cash from the business to owners.

S-Corporations have strict eligibility requirements. One qualification for filing as an S-Corporation is that the business can have no more than 100 owners. None of these owners can be another business. All owners must be U.S. citizens or residents. Certain business types, like financial institutions and insurance companies, may be ineligible. A corporation’s owners can elect to file as an S-Corporation by submitting a form to the IRS.

C-Corporation

C-Corporations have fewer restrictions than S-Corporations. They can be owned by an unlimited number of shareholders. Both individuals and other businesses can own shares of a C-Corporation.

C-Corporations are taxed on their profit at the corporate tax rate. If any cash is distributed from the corporation to a shareholder, the shareholder must also pay tax on the distribution. This is known as “double taxation.”

Non-Profit Corporations

Non-profit corporations are legal entities that do not operate to make a profit for their owners. Churches and charity organizations are two common examples. Organizations that advance certain purposes and do not generate a profit for their owners exempted from federal tax.

Publicly vs. privately held Corporations

Many of the most well-known corporations in America are publicly held corporations. This means that their shares are traded on a public exchange, like the New York Stock Exchange (NYSE) or the Nasdaq. Anyone that can afford a share can become an owner of publicly traded corporations.

Privately held corporations are all other corporations. The vast majority of corporations are privately held. In fact, only about 4,000 companies are publicly traded in the United States.

How do Corporations work?

Corporations can operate in many different ways depending on their size and purpose. Corporate structure may be simple or complex depending on their size. Corporations may be owned by just one person or by thousands of individuals and businesses. Anyone can create a corporation.

How are Corporations structured?

Corporate structure can be easily understood by examining the roles of three categories of people.

  1. Shareholders are the owners of a corporation. “Common stock” shareholders (as opposed to “preferred stock”) have the right to vote to elect or remove directors.

  2. Directors form the “board of directors.” The board makes overall strategic decisions for a corporation. They are responsible for appointing the chief executive officer, or CEO. They are responsible for earning profit for the shareholders.

  3. Officers oversee the day-to-day operation of a corporation. They are responsible for carrying out the strategies set by the board of directors. The CEO is the most senior officer. Other officers typically report to the CEO.

Keep in mind that for corporations with a single owner, the same person could serve as the sole shareholder, director, and officer. Large corporations often have many layers of management split over many business departments.

How are Corporations formed?

The process for forming a corporation varies from state to state. Generally, states require the owners of the new corporation to fill out and file “articles of incorporation.” Most state governments make these articles available as a fillable form on a government website. States charge a filing fee, usually about $100, when the articles are submitted. The form typically requires the following information (but varies among states):

  1. Name of the corporation

  2. Address of the corporation

  3. Name and address of an agent (the person who will receive official correspondence from the state)

  4. The number of shares the corporation can issue

  5. Names and signatures of incorporators

In addition to the articles of incorporation, most states require corporations to have “corporate bylaws.” Bylaws provide rules for how a corporation is structured and how it will operate. It describes the rights and responsibilities of shareholders, directors, and officers. To read more about forming a corporation, check out this article: 8 Tips for Starting a Corporation.