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6/13/07

The Corporation

The corporation is probably the mother of all limited liability entities. The case law is vast and the complexities are many. However, a corporation can be a great business form if you know what the differences between the various corporations are.

As I stated in a previous post, corporations are subject to double taxation. A dollar earned by the corporation is taxed once as a corporate earning and then taxed again upon distribution to shareholders. However, this is not true for all types of corporations. An S-corporation (named after sub-chapter S in the relevant IRS code) is a pass-through entity. This means that the corporation is taxed as a partnership. Therefore, no double taxation! Unfortunately, with benefits come disadvantages. I do not have the code book open in front of me, but I think some of these disadvantages include, amongst other things, limitations of the number of investors you can have (I think you can only have seventy-five (75) investors for an S-corporation), and limitations on who can invest (no other entity, such as another corporation or limited liability company, can be a shareholder).

Keep in mind that when you form your corporation with articles of incorporation, filed with your Secretary of State, you do not form an “S-corporation.” Subchapter S status is received from the IRS, not your state! However, some states require that you state your intention to be an S-corp. in your articles of incorporation. Therefore, check your local laws!

A close corporation is the same thing as an subchapter S corporation, but with stricter limitations (for example, I think some close corporations can only have thirty-five (35) investors). A great advantage exists with close corporations. Close corporations do not have to engage in corporate formalities. Why is this important? When somebody sues the corporation and tries to pierce the corporate veil (meaning the claimant is trying to “pierce the veil of limited liability” and hold the shareholders personally liable), one factor, of many, the court considers in determining whether to pierce is whether the corporation engaged in corporate formalities. If a corporation engaged in corporate formalities (conducted annual meeting, recording minutes, etc.) this supports the conclusion that a corporation did not misuse the corporate form and, therefore, is less likely to have its “veil” pierced. If you have a close corporation, corporate formalities do not have to be conducted, and a court cannot hold that against you should any lawsuits arise.

A closely held corporation is a term of art. There is no special filing or advantage to a closely held corporation. A closely held corporation is one in where the shareholders and the directors are the same people. Usually about five shareholders will exist, and each will also be a director, if not also an officer, of the corporation. In case you are wondering, shareholders elect directors and directors elect officers.

This post is intended to give you a brief overview of some of the corporate forms that exist. Like always, check with a professional before trying to form one of these entities by yourself.

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