- December 26, 2018 10:37 am
Even though corporations affect almost every aspect of your daily life, if we put you on the spot and asked you to define “corporation,” how well would you do? You may say that it’s a company that has some sort of status apart from the owner or owners, but how exactly does the law see it? How does your accountant see it? Why do so many businesses exist as corporations? Why are we putting you on the spot like this?
Legal Entity and Tax Entity
To explain what a corporation is, especially regarding how it compares to other types of businesses you could form like a sole proprietorship or LLC, let’s talk about a couple of important terms: legal entity and tax entity.
“Legal entity” is its own person in the eyes of the State and the law. It can incur and pay debts, be liable for its own actions, enter into contracts, be sued, and generally be treated as a flesh-and-blood person. Business owners often choose to form a corporation or limited liability company (LLC) because it allows the company to create a legal entity that is separate from themselves. Thus, if the business is sued or incurs debt, those seeking payment or reimbursement will go after the business instead of the business owner.
“Tax entity” refers to how the business is taxed. A C corporation, for example, incurs “double taxation” in that both the corporation and the owner are taxed. The corporation is taxed as its own legal entity—when the C corporation makes income, it pays taxes on that income. When shareholders of the C-corporation receive their share of that income, they pay taxes on it on an individual basis.
A corporation is a company that is its own legal entity in the eyes of the State and is owned by “shareholders,” individuals who own a percentage of the company. These shareholders may be made up of those who founded the corporation as well as individual investors. The shareholders share in the corporation’s profits without taking on the liability or debt of the corporation. Shareholders elect a board of directors to oversee the day-to-day operations of the company.
To further define what a corporation is, it helps to contrast it with another popular business model, the LLC. The following chart shows the pros and cons of each:
Benefits of a Corporation
Let’s review some of the key benefits to forming a corporation:
Disadvantages of a Corporation
There are also substantial disadvantages to having a corporation:
Different Types of Corporations
It’s important to know the differences between the three most common types of corporations when deciding which is best for your needs:
Now that you can answer the question “What is a corporation?” when someone asks, maybe you can better decide whether it’s the right business model for your company. Also, see our blog post “What Is an LLC?” for more information.
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