What is a Corporation?

A corporation is a separate and distinct legal entity. This means that a corporation can open a bank account, own property and do business, all under its own name. The primary advantage of a corporation is that its owners, known as stockholders or shareholders, are not personally liable for the debts and liabilities of the corporation. For example, if a corporation gets sued and is forced into bankruptcy, the owners will not be required to pay the debt with their own money. If the assets of the corporation are not enough to cover the debts, the creditors cannot go after the stockholders, directors or officers of the corporation to recover any shortfall.

A corporation is managed by a board of directors, which is responsible for making major business decisions and overseeing the general affairs of the corporation. Like representatives in Congress, directors are elected by the stockholders of the corporation. Officers, who run the day-to-day operations of the corporation, are appointed by the directors.

One major disadvantage of a traditional corporation is double taxation. A traditional corporation, known as a C-corporation, pays a corporate tax on its corporate income (the first tax). Then, when the C-corporation distributes profits to its stockholders, the stockholders pay income tax on those dividends (the second tax). Therefore, tax is paid twice on the same income.

To avoid double taxation, corporations can make a special S-election to be taxed only once on the shareholders personal tax returns. Corporations that make this tax election are known as S-corporations. Why wouldn’t every corporation make this valuable election? Not every corporation can qualify.

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