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Business & Corporate Law

July 22, 2024

LLP, S Corp, C Corp, what type of corporation suits your business needs?

Each different type of law considers a corporation a separate legal entity which has the right to enter into contracts, to own personal property and real estate, and to sue and be sued. As a result, the stockholders of a corporation assume no personal liability for the debts of the business. Their risk is limited to the amount of their investment in the firm. This limitation on personal liability is one of the chief benefits of using the corporate form for your business. Another advantage of a corporation is a stockholder's ability to sell his interest in the company without first obtaining the approval of other stockholders. And unlike sole proprietorships or (as we'll se in a moment) partnerships, a corporation can continue to exist indefinitely regardless of whether investors or owners quit, die, or declare bankruptcy.

In some cases, however, establishing your business as a corporation provides less protection than you might think. For example, many lenders and suppliers to small corporations will require what's known as a "personal guarantee" -- the promise of a shareholder in the corporation to be personally responsible for the corporation's debt if it defaults. And if the corporation is run in a way that makes it impossible to distinguish between its activities and those of its shareholders, a court can "pierce the corporate veil" and impose personal liability on the corporation's stockholders.

For example, the laws in most states require corporations to hold an annual meeting and keep minutes of the decisions made by the corporation's board of directors. A corporation that fails to meet this legal requirement could be found to have forfeited its corporate status, and the owners of the corporation could be held personally responsible for the actions taken by the corporation.

There are some major disadvantages to organizing your business as a corporation. One such disadvantage is the extra paperwork necessary. Another is the possibility that the corporation's profits will be subject to double taxation. Because a corporation has the status of an "artificial person" it must pay taxes on its profits. And when the stockholders receive some of those profits in the form of dividends, they are taxed again as income to the stockholder.

To avoid this double taxation, many small corporations operate as "S Corporations." Under the federal Internal Revenue Code, a corporation which elects to operate as an S Corporation pays no income taxes on its profits. Instead, taxes are paid by the shareholders of the corporation on their personal returns.

Not every corporation can qualify for this special tax treatment. To obtain IRS approval as an S Corporation, the corporation must be corporation organized under the laws of one of the states, and not a foreign corporation. It must have no more than 75 shareholders, none of whom are non-resident aliens. In addition, only individuals, estates, or trusts can own stock in the corporation. Finally, the corporation can issue only one class of stock.

To become an S Corporation, the company must file Form 2553 with the Internal Revenue Service. S Corporation status can continue indefinitely, provided all the above conditions continue to be met. However, S Corporation status ends automatically as soon as any one of these conditions changes in a way that disqualifies the corporation from S Corporation treatment. For example, if another corporation bought stock in the S Corporation, the S Corporation status would terminate, since only individuals, trusts, and estates can own S Corporation stock.

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