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What is a Corporation?

Corporation LawA corporation is a legal entity, set up under the guidelines of state law, which essentially stands in the place of its owners, who are known as shareholders. The corporation is customarily invested with powers to act as a person, to enter into contracts, to incur debt, to obtain and sell property, and to engage in a wide range of other activities.

A corporation must be set up in accordance with the business laws of a particular state. Generally, this requires the filing of articles of incorporation, as well as by-laws and other documents. Corporations generally issue certificates of stock, which identify ownership within the corporation. Most states require that corporations file certain annual reports, that any actions of a corporation be done by either corporate resolution or by vote of the shareholders, and that corporations conduct shareholder meetings on a specified basis.

A corporation may be public or private. A public corporation is one whose stock is available for purchase by the public, customarily through an exchange (the New York Stock Exchange, for example). A private corporation, on the other hand, is one where ownership (shares) is not publicly traded.

The Benefits of the Corporate Form

The principal benefit of the corporate form is the limitation of liability. As a general rule, a shareholder in a corporation will only be liable for the value of his or her investment. If a company fails, or if there is litigation against a company, the most the shareholders can potentially lose is the amount they paid to purchase the stock.

With certain types of corporations, you can also avoid a business tax, instead paying income tax on distributions as part of your personal tax filing.

The Different Types of Corporations

Corporations may be designated as:

  • Subchapter C corporations (under Subchapter C of the Internal Revenue Code)—Subchapter C corporations pay a tax separate from shareholders/owners. Subchapter C corporations typically have a large number of shareholders, but there is no requirement with respect to the number of shareholders, other than the rule that any corporation with more than 100 shareholders must be a C corporation.
  • Subchapter S corporations—A subchapter S corporation is a “pass-through” entity. This means that the liability for income tax passes through the corporate to the individual shareholder, and is reported as personal income. An S corporation may not have more than 100 shareholders, and its shareholders must be U.S. citizens or residents, as well as natural persons (corporations and partnerships may not be shareholders in an S corporation).
  • Closely held corporations—This is simply a corporation that has a limited number of shareholders. It may or may not be publicly traded.
  • Nonprofit corporations—These entities are not set up to pass on a profit to investors, and enjoy certain tax and other benefits if they comply with state and federal laws.

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