A corporation is a business that's a separate tax entity from its owners. Most corporations have shareholders as their owners. The shares can be closely held by only a few individuals, or they might be offered for sale to the public so they're "publicly held."
Non-stock corporations can be either non-profit or a for-profit business. They can be very closely held or formed for a specific short-term purpose.
What Is a Corporation?
A corporation is owned by its shareholders or stockholders, each of whom owns a piece of the corporate pie. These individuals have each invested money in the business entity. Most corporations are closely held with shares owned by just a few individuals.
Corporations are taxed separately from their owners at the corporate tax rate. A corporation pays taxes based on its net income or profits each year because it's a separate tax entity. IRS Form 1120 is prepared to calculate the tax liability of the corporation.
How Does a Corporation Work?
The process of starting a corporation—called "incorporating"—is somewhat complicated because of the number of documents that must be prepared and filed. Corporate bylaws must be drafted to govern policy for the corporation. Corporations must also submit articles of incorporation to the state in which they're doing business.
Other tasks in the incorporation process involve electing officers and other general business startup tasks.
Corporations have a board of directors at the highest level, and this board sets policy and manages oversight. The board makes sure that the corporation is acting according to its mission and its bylaws, and that it complies with federal, state, and local rules and regulations.
Corporate executives are one level down from the board, and they run the day-to-day operations of the business. They might also be shareholders and some might sit on the board of directors, depending on how the corporation is structured. These executives are paid employees.
Corporations reserve the right to create their own stock structures, and it's this provision that ultimately results in double taxation of both the business and its shareholders on the same profits.
Types of Corporations
The two basic types of corporations are those with stock and those with no stock. Corporations can also be non-profits.
Corporations have an option as to how they're taxed. They can elect to be taxed as Subchapter S corporations and notify the IRS of this election. Profits are then taxed when they're passed down to shareholders, and shareholders report those profits and deductions on their own personal returns, but some restrictions apply:
- S corps must be domestic corporations.
- They can't have more than 100 shareholders.
- Shareholders must be individuals, trusts, or estates.
- Partnerships, other corporations, and non-resident alien shareholders will not qualify as shareholders.
- S corps can have only one class of stock.
A corporation that does not specifically make this election is taxed as a Subchapter C corporation.
C Corporations and Double Taxation
Corporations have a unique issue in the business world—"double taxation." The corporation is taxed on its profits, then the owners or shareholders of the corporation are also taxed on the dividends they receive based on those profits. Corporations are not permitted to claim a deduction for profits passed on to shareholders.
Shares held by religious organizations, in retirement accounts, or by education institutions aren't subject to this second level of tax.
The debts and liabilities of corporations are also separate from those of the owners, however. This separation is sometimes called a "corporate shield" because the corporate structure shields the owners and employees from personal liability.
Who Pays the Shareholders?
Shareholders receive dividends from the corporation's profits based on the number of shares of stock they own. Corporate owners and others who work as employees are paid based on salaries, but they might also receive dividends as part of their benefits packages.
- A corporation is a business that’s recognized as a separate tax entity from its owners or shareholders.
- Corporate owners hold shares of stock within the business entity.
- Subchapter C corporations are subject to double taxation on the same profits, once at the corporate level then shareholders are again taxed personally on their earned dividends.
- Corporations can elect to be recognized as Subchapter S corps to avoid double taxation, but some strict rules apply.