A corporation is generally formed by one or more individual owners (shareholders or stockholders) filing articles of incorporation with the Florida Secretary of State. As part of the formation there are other corporate records that must be created and kept as part of the corporation’s official records (such as by-laws and corporate minutes as well as the corporate stocks). It would be a big mistake for two or more individuals to go into business together as shareholders in a corporation without a written shareholder agreement.
Assets are typically owned by the corporation and deployed in the business venture. Problems can arise when business assets are not properly designated as being owned or not being owned by the corporation. Care needs to be given to each asset used by the business to make clear who owns the particular asset in question.
Liabilities, such as for office supplies and the like, are generally the responsibility of the corporation, as opposed to the shareholders. In the event a corporation fails, the individual shareholders are typically not responsible for the unpaid debts of the business.
Typically a corporation is operated under the legal name of the corporation. The shareholders may wish to use a business name different from the name of the corporation, and may protect the use of the business name by making a fictitious name filing with the Florida Secretary of State.
A new corporation can usually be created and assets transferred to it in a tax free transaction. The profits and losses from the operations of a corporation are reported on IRS Form 1120 for federal income tax purposes. The corporation pays taxes on its income, and then the shareholders report and pay taxes on any dividends they receive from the corporation. So there is two levels of taxes on the same income. Once in the hands of the corporation, and once in the hands of the shareholders. This has been the single largest draw back to using a corporation as a business vehicle until the tax laws were changed to allow certain qualified dividends to be taxed at capital gain tax rates. This law is scheduled to expire at the end of the 2010 tax year. A corporation must keep separate books and records for the corporation’s financial activities. The State of Florida imposes an income tax on the profits or losses of a corporation doing business in the State of Florida.
A corporation may have real estate associated with its business operations. As with other assets, the corporation typically owns any real estate used incident to the business operations of the corporation. If the property is owned by one of the shareholders, another business entity or a third party, the corporation typically pays rent to the owner for its use of the real property. Generally speaking, real estate that is used by the corporation for things like its offices or store front may not cause a problem if owned by the corporation; however, other kinds of real estate, such as rental apartments, should generally not be owned by a corporation. Partnerships and limited liability companies are a more efficient vehicle in such circumstances.
Sale or Exchange
Corporations typically own all of the assets used in the business, and any sale or exchange of the business can be a sale or exchange of the assets and liabilities of the business or of the stock of the corporation. A sale of the assets can result in gain taxed at ordinary income (usually higher) tax rates, while a sale of stock can result in any gain being taxed at capital gain tax rates.
All businesses need to actively manage their business risks, including corporations. The assets and liabilities of the business belong to the corporation, but the individual shareholders are generally not responsible for any corporate debts. Nevertheless, a corporation must obtain appropriate insurance coverage (hazard, liability, workers’ compensation, and the like). Any unexpected claims that are not covered by insurance can quickly consume any equity the shareholders have in a corporation. One of the major benefits of a corporation is that the shareholders are not generally responsible for the corporation’s debts.
In the event of a shareholder’s death, disability, or bankruptcy, the corporation may generally continue its business. In the event of death, the shareholder’s interest in the corporation (rather than the corporation’s assets) generally becomes part of the deceased shareholder’s probate estate, and is ultimately distributed in accordance with the terms of the shareholder’s last will and testament. Regardless of the nature and extent of the business’ assets and liabilities, it is possible to keep the corporation and its business in tact. As part of the formation of a corporation with more than one shareholder, it is very important for the shareholders to come up with a business succession plan that includes consideration of the death, disability, bankruptcy, retirement, and or other withdrawal of a shareholder from the corporation.
Termination and Winding Up
A corporation may be terminated and its affairs wound up. The shareholders should consider the income tax consequences to the termination and winding up before they decide to actually end the business operations.
Corporations can be very useful when the shareholders are other limited liability entities, such as other corporations. Proper use of tiered corporate ownership can separate various different business activities and associated risks from each other.
Generally speaking, all of the discussions with respect to corporations hereinabove in section III apply to S corporations. The major difference relates to the taxation of S corporations. Only certain businesses may elect to be taxed as an S corporation. In addition, the business cannot have more than 100 shareholders, have shareholders who are other than individuals, estates, or certain trusts (or certain tax-exempt organizations). There can be a tiered S corporation structure, but the parent S corporation must own 100% of each subsidiary. Nonresident aliens may not be shareholders, and the business can only have one class of stock (this can be very important when trying to figure out how to compensate two or more shareholders who have contributed differing amounts of capital and services to the corporation). The income tax result of having a corporation elect to be taxed as an S corporation is similar to the taxation of a partnership.
S Corporation Continued
The corporation files an IRS 1120S tax return reporting the profit and loss for the corporation, and the separate corporate items of profit and loss are the allocated among the shareholders on Schedule K-1. The respective shareholders then report their share of the corporation’s profits and losses on their individual tax returns (Form 1040), and pay taxes on the income. The corporation does not pay any corporate income taxes to the federal government; however, an S corporation must pay corporate income taxes to the State of Florida. The S corporation vehicle is generally most useful when the business is largely engaged in the provision of personal or professional services. The ownership of real estate can present certain tax issues for the S corporation, and this should be considered prior to having an S corporation acquire any real property.