Corporations are businesses that are treated like individual people by the law. A corporation can own assets, hire employees, sign contracts, and exercise individual rights.
In this post, learn the full definition of a corporation, including how corporations are formed and how they operate.
What is a corporation?
A corporation is a type of business that the law treats like a single person. This means a corporation can do things like buy a car, sign a deal with a supplier, or borrow money to rent office space.
While a corporation is treated as an individual, it can be owned by multiple shareholders. Shareholders are served by an elected board of directors, who oversee officers that handle the day-to-day running of the company.
Limited liability
Corporations are a popular business model because they protect shareholder assets. When a business incorporates, its actions and assets become separated from its owners, in a concept known as limited liability.
In a limited liability company, shareholders are not personally responsible for the corporation’s debts or actions. A shareholder in a corporation isn’t liable for the corporation’s contractual obligations or any harm the corporation may cause to a third party.
For example, if a corporation owes money or faces a lawsuit, shareholders’ homes and bank accounts are typically safe. Their financial risk is limited to their investment in the corporation, so they can only lose the amount they’ve invested.
Types of corporations
While there are several types of corporations, most of them fall into one of three main categories:
C corporations
C corporations are the most common type of corporation. In this corporation type, businesses are legally separate from their owners, who aren’t personally responsible for the corporation’s liabilities. C corps can have unlimited shareholders, making them ideal for large businesses.
S corporations
S corporations are similar to C corporations, but they have a special tax status with the IRS that allows profits (and some losses) to be passed directly to owners’ income without being subject to corporate tax rates. However, S corps are also subject to certain restrictions, such as a limit on the number of shareholders.
Nonprofit corporations
Nonprofits are formed for charitable, educational, religious, literary, or scientific purposes. Profits don’t benefit individuals, and the corporation enjoys special tax exemptions as a result.
Each type of corporation has its own set of rules, benefits, and considerations. Choosing the right one for your business depends on a variety of factors, including the size of your company, the number of owners, and its long-term goals.
How do corporations work?
A corporation is created when a group of shareholders with a common goal decide to incorporate a separate legal entity. Each shareholder’s ownership in the corporation is represented by their holding of stock.
Shareholders
Shareholders are the owners of a corporation. They receive a share of profits from the business, often in return for an investment of money or labor. Ownership is represented by common or preferred shares issued by the corporation.
A majority shareholder is someone who holds more than 50% of a company’s shares. Sometimes, a private corporation will have a single shareholder. However, most have multiple shareholders, as with publicly traded corporations.
Anyone can buy and sell the shares of a publicly traded corporation on the stock market.
Board of directors
Before a corporation begins doing business, it must vote for a board of directors. Shareholders elect directors during an annual general meeting, with each shareholder receiving one vote per share.
The board of directors makes decisions on major issues affecting the interests of shareholders. They also create policies to guide the corporation’s management and daily operations, which are carried out by the corporation’s chief executive and other officers.
Directors owe a duty of care to shareholders. They must act in the best interests of the shareholders and the corporation.
Taxes
Corporations are required to file and pay taxes as a business entity. The exact tax laws and forms can vary depending on the size and type of corporation formed, such as a C corporation or S corporation.
Because they’re seen as separate entities, corporations are taxed independently of their owners. Here is more detailed tax information for corporations from the IRS.
Forming a corporation
You can register your business as a corporation in any location—not necessarily where you’re based or do business. That’s why corporations are often formed in states considered pro-business, such as Delaware or Nevada, or in overseas jurisdictions with favorable tax rules.
The process for forming a corporation varies depending on the state or country, but two components are universal: articles of incorporation and by-laws.
Articles of incorporation
Articles of incorporation act as the birth certificate of a corporation. These documents are filed with the state secretary (or equivalent department) and legally establish the corporation’s existence.
Articles of incorporation typically include:
- The corporation’s name and address, which must be unique
- The corporation’s purpose, including a description of the goods or services the business will provide
- The corporation's duration, if it’s not intended to exist perpetually
- The number and type of shares the corporation is authorized to issue
By-laws
By-laws serve as a corporation’s internal rule book. They provide the framework for operations and management, outlining how the corporation will be run.
A corporation’s by-laws typically cover:
- How often the board of directors will meet
- Roles, responsibilities, tenures, and powers of directors
- Shareholder rights and obligations, including processes for selling shares and receiving dividends
- Procedures for handling disputes and organizing votes
By-laws can be amended as needed once the corporation has been formed.
Pros and cons of forming a corporation
Forming a corporation is a significant decision. It’s important to weigh the advantages of structuring a business as a corporation with the time and resources required to keep it running.
Corporation Pros
Corporations offer several key benefits. Here are four pros of running a business as a corporation:
- Limited liability: A corporation provides liability protection for its shareholders. This means shareholders are typically not responsible for the corporation’s debts and liabilities.
- Raising capital: Corporations can more easily raise funds than other types of business by selling shares.
- Lower tax rates: While corporate profits are taxed, the rate is often lower than the personal income tax rate individuals pay.
- Employee owners: Potential employees may find the prospect of ownership benefits to be an incentive.
Corporation Cons
However, forming a corporation also comes with drawbacks. Here are four potential downsides to corporations:
- Complexity and costs: C corporations are expensive to set up and maintain. They require significant paperwork and adherence to many regulations.
- Ongoing regulatory and admin costs: Once established, corporations can incur substantial costs to stay compliant with changing business regulations and timely filing of paperwork.
- Double taxation: Corporations pay federal, state, and sometimes local taxes on profits. Additionally, dividends paid to shareholders are taxed again on the shareholders’ personal income tax returns.
- Reserved for large organizations: Due to their complexity and cost, corporations are often best suited for large organizations with many employees.
Entrepreneurs Inc.
Incorporation allows businesses to grow, raise capital, and limit liability, making it a popular choice for many entrepreneurs. If you’re looking to register your business, see how corporations compare to other business structures.
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Corporation FAQ
What is a corporation in business?
A corporation is a standalone legal entity. It’s legally separate from its owners, known as shareholders, and has its own legal rights and responsibilities. Shareholders’ financial risk is limited to their investment, protecting their personal assets from the corporation’s liabilities.
What is the difference between a limited liability company and a corporation?
Limited liability companies (LLCs) and corporations both protect owners from personal liability. However, there are differences between the two business models. LLCs have simpler management structures and benefit from pass-through taxation, avoiding corporate taxes. Corporations, on the other hand, have a formal management structure and face double taxation at both corporate and personal levels.
What is the difference between a company and a corporation?
The term “company” refers to any business involved in commercial activities, while a corporation is a specific type of company. Corporations are defined by a separate legal status from owners, conferring limited liability protection. So, while all corporations are companies, not all companies are corporations.
What is an example of a corporation?
Most large businesses are corporations. Take Apple Inc., for example. As a corporation, Apple is overseen by a board of directors who guide its strategic direction, while CEO Tim Cook and other officers manage daily operations. Apple also holds annual meetings, where shareholders vote on crucial company matters.
