As most business owners know, the type of organization can spell the difference between business success and failure. The right corporate structure not only improves daily operations, but also provides certain advantages in terms of legal and financial protection. These days, more and more companies are incorporating, or registering their businesses as corporations.
What is a corporation?
A corporation is legally recognized as a “person” separate from those who own and operate it. As such, its finances (debts, taxes, etc) are handled separately from those of its owners. Its main advantage is liability protection – the owner’s personal assets will remain intact if the business gets sued, goes bankrupt, or ends up in a similar unfortunate situation. And because it is considered a separate person, it continues to exist even after the death of an owner or shareholder, offering great advantages for estate planning.
How does a corporation work?
A corporation enjoys the status of a person of legal age, which gives it freedom to perform all aspects of the business. They are authorized to do business in the state of incorporation (and in any other state where it holds a license to operate), buy or sell, give or take out loans, enter contracts, and other important operations. They also get a social security number, classified as an employer identification number (EIN) so as to exempt them from social security taxes. This is because they do not require the same protection as physical persons.
What goes into a corporation?
Corporations are owned, but not managed, by stockholders. Stockholders can only indirectly influence corporate decisions – by electing directors, voting on corporate matters, and approving or rejecting amendments to the articles of incorporation. The major decision-makers are the directors – collectively called the Board of Directors – who are also responsible for day-to-day decisions and appointing officers. Officers in turn manage the daily operations of the company. A stockholder can also serve as director and officer, making it possible for a corporation to be owned, managed, and operated by one person.
What are the advantages of forming a corporation?
Asset protection: According to USA Today, a company that earns more than $50,000 annually has a 1 in 4 chance of getting sued within the next year. For small business owners, losing their business in addition to everything they own is too stressful to even think about. Incorporating allows you to enter an Asset Protection plan, where you structure your business in a way that protects your personal assets separately from your business assets. Without such a backup, you stand to lose everything, including your retirement plan, in the event of a lawsuit. In a corporation, everyone involved, from the stockholders to the officers, are protected from liabilities outside of the business.
Privacy: Privacy is a major concern for business owners because in a way, it reduces their chances of getting sued. That is because people will want to know how much you are worth before they file a lawsuit. A corporation allows you to protect your personal wealth from the public eye. Nevada has especially advantageous protective privacy laws that keep the owners’ identities off public records, while still giving them full control over their company.
Tax savings: Corporations are entitled to several tax deductions not available to individuals or other corporate organizations. For instance, a corporation only pays 15% tax for the first $50,000 of profit – the amount left after all expenses are paid – while an individual can be taxed up to 28%. Federal taxes are also lower for incomes above $250,000.
The reason behind these deductions is the difference in cash flow. An individual spends his money after being taxed, but a corporation makes its purchases before taxes. That means a corporation spends pre-tax dollars, which are obviously worth much more than after-tax ones. Many corporate owners have managed to legally zero out their corporate taxes using this strategy.
Benefits: Your corporation can pay for many of your basic needs – health care, education, meals, travel, equipment, and even your car and moving expenses. You can also transfer these benefits to the next generation, since the corporation can outlive you.
Your corporate pension allows you to save tax-deferred money for retirement. With the right insurance plan, a corporation can save on medical insurance premiums by 100%, while other organizations can deduct only about 30%.
Perpetuity: With a partnership, sole proprietorship, or limited liability company (LLC), when you lose a partner you will have to go through miles of red tape to keep the business in existence. A corporation lives no matter what happens to its officers, directors, and even its shareholders.
Types of corporations
C-Corporation: A C-corporation is governed by the state where it is incorporated. It is the most common type of organization, thanks to its many benefits – tax deductions, asset protection, and an unlimited number of stockholders. Nevada Corporations must be of this type to avail of tax benefits.
S-Corporation: This is a special type of structure created solely to avail of a special IRS tax status. It allows small business owners to be taxed as partnerships or sole proprietors, but still enjoy the asset protection offered by C-corporations.
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