A corporation is an entity that acts as a single, fictional person. Much like an actual person, a corporation may sue, be sued, lend, and borrow. Additionally, a company which has been incorporated can easily transfer ownership through stock sales and exist indefinitely.
Corporations are primarily authorized and governed by state law with many states following the Model Business Corporation Act provided by the ABA. These state corporation laws typically require articles of incorporation to document the corporation's creation and to provide provisions regarding the management of internal affairs. Most state corporation statutes also operate under the assumption that each corporation will adopt bylaws to define the rights and obligations of officers, persons, and groups within its structure.
While primarily governed by state law, certain aspects of corporations are governed by federal law. In particular, the Securities Act of 1933 requires most corporations offering stock to file with the Securities Exchange Commission (SEC) and to regularly disclose financial statements/other executive information.
One of the primary benefits of incorporating is limited personal liability. Generally, the only personal assets a shareholder of a corporation can lose in a lawsuit or to pay off corporate debts is their investment in that corporation. In cases of extreme misconduct, however, a lawsuit may necessitate targeting individual shareholder’s assets through what is known as piercing the corporate veil. The exact requirements necessary to pierce the corporate veil vary from state to state.
The primary downside of a traditional corporation is its lack of pass-through tax status. Pass-through tax status allows an entity to avoid paying taxes on its income and instead pass that income to its owners, who then pay taxes individually. Because of this lack of pass-through tax status, corporate income is subject to double-taxation.
- For example, if a corporation with 10 shareholders records a profit of $100,000 and the universal tax rate is 10%, only $90,000 will be given to shareholders for a $9000/shareholder profit.
- This $9000 profit will again be taxed at the individual level and each shareholder will walk away with $8,100.
- This double-taxation problem led to the creation of S-corporations.
[Last updated in July of 2022 by the Wex Definitions Team]