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A corporation is a distinct legal entity separate and apart from its shareholders or owners. Corporations are pure creations of law. They are formed and governed by the laws of the state in which the corporation takes place. Corporations can do business in various forms: C-Corporation, S-Corporation, Limited Liability Company and Professional Corporation (Professional Association). The existence of a corporation is perpetual, that is it continues to exist until dissolved by the corporation or the state, as for failure to pay annual fees. Each corporate form will be discussed separately below.
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Corporate existence begins with the filing of Articles of Incorporation (in some states referred to as Certificate of Incorporation, Articles of Association or Articles of Organization) with the Secretary of State in the state of incorporation together with necessary filing and license fees. Depending on the state, the filing fees for a corporation are generally several hundred dollars.
Articles of Incorporation
The Articles of Incorporation must be prepared in accordance with state legal requirements. Ordinarily, the Articles must contain the name and address of each incorporator (individual(s) forming the corporation), the corporate name and address, the name and address of the registered agent of the corporation, the authorized number of shares of stock, the names and addresses of the first board of directors, and the par or no-par value of shares of stock. The incorporator(s) and the registered agent must sign the Articles of Incorporation.
Ordinarily, before filing Articles of Incorporation, the incorporators will check or clear a proposed corporate name with the Secretary of State. The Secretary of State maintains a list of names of existing corporations and will not allow incorporation of a new entity with an identical or unfairly similar name. Some states allow the reservation of a corporate name for a period of time before the Articles of Incorporation are filed.
Articles of Incorporation and by-laws (see below) can be amended as required by changing business circumstances. Under state law or procedures outlined in the Articles of Incorporation or by-laws, an appropriate vote to amend by directors and/or shareholders is generally required. Once the Articles of Incorporation are amended, a certificate of amendment is prepared and filed with the state. By-Laws can be amended without any state filing requirements.
Since corporations are artificial entities, a registered agent must be designated to receive notices from the state and lawsuits. Upon receipt of a notice or a summons and complaint, the resident agent will ordinarily immediately remit these documents to the president or other responsible officer of the corporation for further action.
Except for certain states that impose shareholder liability for unpaid wages in small corporations, one of the major advantages of the corporate form of doing business is the limited liability of incorporators, directors and shareholders. Liability for corporate debts is ordinarily limited to the amount of money that has been invested in the corporation, as the corporation is recognized as being a separate legal entity. Accordingly, if the corporation fails to pay its debts and liabilities, only the corporate assets can be seized or attached by creditors- the creditors cannot seek to satisfy corporate obligations through the shareholders, officers or directors. The limited liability aspect of corporations applies to corporations irrespective of what type of tax election it may have made (e.g., S-Corporations).
Piercing the Corporate Veil
In certain limited instances, creditors or litigants can attempt to impose personal liability on principals in the corporation by claiming that the corporation is a sham, a device created merely to defraud creditors, or is being run as a sole proprietorship (e.g., no shareholder’s meetings or director’s meetings have taken place; there has been a commingling of corporate and individual property). The process of imposing individual and personal liability is referred to as “piercing the corporate veil” or “disregarding the corporate entity”. Ordinarily, a party seeking to pierce the corporate veil will have a heavy burden in attempting to persuade the courts to disregard the corporate entity.
Corporations are artificial entities; management decisions are made on several levels, depending on the nature of the decision.
Board of Directors
The Board of Directors sets corporate policy but is ordinarily not involved in day-to-day operation of the corporation. Directors, who may also be shareholders or officers, serve for a specified term and may be removed for cause, that is, if they act unlawfully, improperly or not in the corporation’s best interest.
The remaining board members generally fill a vacancy in the Board of Directors until the ensuing shareholder’s meeting.
Limitations on Board of Director’s Powers
Directors generally are not required to obtain stockholder approval for business decisions; however, certain actions ordinarily do require stockholder approval. Usually, a sale or disposition of all or substantially all of the corporation’s assets not in the usual and regular course of business, mergers, consolidations or dissolutions of the corporation requires the approval a majority or 2/3 of the shareholders.
Profits of a corporation may be distributed as dividends. The decision of whether or not to declare a dividend is made by the Board of Directors. Even if the corporation makes a profit, the Board of Directors may elect to retain the profits and utilize them for expansion or other purposes instead of distributing the profits to the shareholders. Dividends are distributed to shareholders in accordance with their relative ownership interests.
The officers of a corporation manage the day-to-day operation of the business and are responsible for implementing policies established by the board of directors. As such, the officers are subject to the control of the Board of Directors and may be removed when the Board of Directors determines that removal is in the best interests of the corporation.
Officers, as well as Directors, occupy a fiduciary relationship to the corporation, that is, they owe a duty to the shareholders to act in the best interests of the corporation.
Stockholders own the corporate stock. Shares of stock represent an equity (ownership) interest in the corporation. As the true owners of the corporation, stockholders elect the directors, amend by-laws and Articles of Incorporation, remove directors and vote on major corporate issues, such as mergers and dissolutions. Shareholders ordinarily are not directly involved in the management of the corporation. While profits of the corporation may be distributed to shareholders in the form of dividends and shareholders may sustain profits or losses on the sale of their shares of stock, shareholders are at risk only up to the amount they have invested in the corporation. (See limited liability below). Corporations must hold at least one shareholder’s meeting each year.
Shares of Stock
Corporate shareholders may ordinarily freely sell, transfer or assign their stock. The ability to sell their interest in the corporation offers shareholders the ability to convert stock interests into liquid cash. Likewise, shares of stock are ordinarily capable of being devised in a will to beneficiaries. The shareholders of a corporation may however agree to place restrictions on the sale or alienation of shares of stock through a shareholder’s agreement (see below).
The stock of a corporation represents the interest of the stockholders in the corporate property. Stock and shares are generally used interchangeably. There are various different kinds of stock, including:
- Common Stock – entitles the owning shareholder to a share of the profits of the corporation based upon the percentage of ownership of the corporation represented by the shares of common stock.
- Preferred Stock – gives the owner a preference in distribution of profits, earnings or assets, including distributions made should the corporation be dissolved. Preferred stock may be “convertible” into common stock at a pre-determined ratio.
- Treasury Stock – stock owned by the corporation that was acquired through re-purchase of shares from the shareholders.
- Authorized Stock – total amount of stock that the corporation may issue as necessary. Authorized Stock may either be issued or un-issued.
- Par Value Stock – stock that has a nominal value, i.e. a minimum price.
- No-Par Stock -stock that has no specific fixed value.
A shareholder’s agreement is a written instrument setting out the rights, duties and obligations of shareholders. The agreement may provide that the corporation or shareholders have the first right of refusal to purchase shares of stock and that no shareholder may sell his/her stock without first offering them for sale to the corporation or other shareholders upon the same terms and conditions that the offering shareholder extends to third parties. Management responsibilities and compensation terms are often spelled out in a shareholder’s agreement. The agreement will address such issues as withdrawal of officers, deadlocks in management, buyout price, evaluation and other contingencies.
By-laws, the rules that govern certain operational and management procedures, are generally prepared at the same time as the Articles of Incorporation. The by-laws are, however, an internal document and need not be filed with the Secretary of State. By-laws of the corporation outline the way the corporation is operated and managed. Ordinarily, the by-laws will set out the date, time and place of the annual meeting of shareholders, will identify the corporate office, set forth quorum requirements, state what voting requirements exist, define the powers of the board of directors, determine the number of directors and their term of office, establish the duties of the president and other officers and provide for how amendments to the by-laws may be made.
A close corporation is one in which the shareholder’s are actively involved in managing and operating the corporate business. Closed corporations may be regulated or controlled through special state statutes. In a close corporation, shareholders ordinarily will agree through a written shareholder’s agreement how management decisions are made and what restrictions may apply to the sale of stock.
Taxes – “C” Corporations
Regular corporations that have not made an election to be taxed as an S-Corporation (see below) are required to pay taxes on corporate income. Thereafter, when profits are distributed to shareholders as dividends, the shareholder must pay income taxes on the distribution at the shareholder’s tax rate. In effect, corporate profits are taxed twice- once at the corporate level, and a second time when distributions of dividends are made to shareholders.
The Internal Revenue Code sets forth how regular corporations are taxed in subchapter C of the code. Accordingly, regular corporations are often referred to as C-Corporations.
Liability for Taxes
Personal and individual liability may be imposed on corporate officers if the corporation fails withhold and remit taxes.
C-Corporations enjoy a tax advantage over S-Corporations in that fringe benefits can be deducted as business expenses.
Taxes – “S” Corporations
The double tax applicable to corporations can be avoided by electing to become an S-Corporation. S-Corporations and C-Corporations are formed exactly the same way. An S-Corporation election (subchapter S) is made pursuant to the Internal Revenue Code and not state corporate law. The purpose of an S-Corporation is to allow small corporations to be taxed like partnerships but still enjoy many of the benefits of a corporation. An election of S-Corporation status must be filed with IRS.
Procedure for Sub-Chapter S Election
The election to be taxed as an S-Corporation is made by filing an IRS Form 2553. Ordinarily, a subchapter S election must filed 2 1/2 months after the beginning of a taxable year or from the time the corporation has shareholders, acquires property or begins doing business.
Qualification as an S-Corporation
In order to qualify as an S-Corporation a corporation must have no more than 75 shareholders; the shareholders must generally be individuals and U.S. citizens; there must be only one class of stock; the shareholders must consent to the S-Corporation election.
Income and Losses
Income, losses and deductions generated by an S-Corporation are passed through directly to shareholders. Subchapter S-Corporations do not pay federal corporate income taxes. The shareholders pay federal taxes on their share of the corporate profits at their individual tax rate. Income and losses are allocated to shareholders according to their ownership interests.
Fringe benefits in S-Corporations are limited to shareholders who own more than 2 percent of shares.
Limited Liability Companies (LLCs)
Limited Liability Companies are a relatively new form of business structure. Profits and losses in a Limited Liability Company can be allocated among owners without regard to their relative ownership interest. Limited Liability Companies can elect to be taxed as either partnerships or corporations. An ownership interest in a Limited Liability Company may be transferable but the transferee does not become a partner without the consent of the other owners.
To form a Limited Liability Company, the organizers must generally file “Articles of Organization” with the Secretary of State. Ordinarily, Limited Liability Companies, as part of the organizational documents, set forth whether the Limited Liability Company will be managed by the members or by the manager and set forth the names and addresses of the members or managers. An agreement, generally referred to as an operating agreement or “regulations”, must also be filed.
Professional Corporations (Professional Associations, PC’s or PA’s) are corporate entities that are reserved to licensed professionals or in the same profession. Professional Corporations are taxed in the same way as a C-Corporation or an S-Corporation depending on the corporate election. Professional Corporations are managed and shareholders have the same rights as in a regular corporation however as a rule, the shareholders will enter in to an agreement defining their relative rights, duties and obligations.
While the existence of a corporation is usually perpetual, a corporation may be voluntarily or involuntarily dissolved.
Generally, the owners of 2/3 of the shares of stock of a corporation can vote to dissolve the corporation. A Certificate of Dissolution must be obtained from the state of incorporation. A notice of dissolution must be published, generally in a general circulation newspaper, to advise creditors that the corporation is being dissolved. Upon dissolution, corporate assets are sold and distributed to creditors and shareholders.
A corporation may be involuntary dissolved by court order or by the state if the corporation has failed to file annual reports or pay annual registration fees. A shareholder can file an action to dissolve the corporation if it can be shown that the directors are deadlocked in the management of the corporation, that the directors or officers are acting illegally or fraudulently, or that corporate assets are being wasted or improperly utilized.
(For other forms of doing business, see Business Organizations)
Hoffman, Larin and Agnetti, PA has litigated thousands of cases since 1975 and is available to plaintiffs and defendants for a free consultation and evaluation involving corporate or business disputes. We have offices in Dade, Broward and Monroe Counties.