What is a corporation?

On: June 21, 2019

A corporation is a legal fiction. It is an entity created and regulated by state law. For all extensive purposes, it is an individual with all the rights and obligations of an individual. It will have its own EIN (employer ID #) which serves it the same as a social security number. It is taxed and sued as if it were its own legal individual self. The primary purpose of a corporation, in whatever form, is to protect and limit the liability of the owner(s). It is a legal individual in its own right. If it gets sued and loses, only the money and assets owned by that corporation can be collected on. The shareholders’ liability is limited to money invested in the corporation. A shareholder’s assets, beyond that invested in the corporation, are not subject to the corporation’s losses. CORPORATE TAXATION  C-Corporations – This is the most basic corporation. Corp. X (“X”) makes $1M. There is only one shareholder/owner (you). Tax rate = 35% = $350K. $1M – $350K = $650K. You leave $300K in X for operating expense and growth/marketing for next year. You take the $350K. It is treated a dividend and it is taxed again as your personal income at 28%. $350K x 28% = $98,000. $350K – $98,000 = $252,000. THIS IS DOUBLE TAXATION. This is the problem. The benefits of the corporation remain protection from liability and the ability to retain earnings to allow the corporation to grow over time. Pass-Through Corporations (This includes S-Corps, LLCs, LLPs, Limited Partnerships) – These pass-through entities were created to avoid the double taxation issue. X makes $1M. There is only one shareholder (you). All income, loss, assets and liabilities pass-through the entity and all taxation occurs at your individual level. $1M  to you x 28% = $280K. $1M – $280K = $720K to you.  The benefit is reduced taxes. The problems are you are not allowed to retain anything in the entity for next year or growth. It protects you from liability in case it gets sued EXCEPT IN THE CASE OF A SINGLE MEMBER PASS THROUGH ENTITY BEING COLLECTED ON BY THE IRS. The IRS and other taxation entities can “reach through” single member entities and attach the single member’s assets, income, and other sources of repayment. Sole Proprietorships – This is just you doing business as an individual (no corporation). You file your taxes using your Schedule C and take your business expenses against your business gross income to equal your business’ net income which is your personal gross income. YOU ARE NOT PROTECTED FROM LIABILITY (as with a corporation). Note: This is not a complete list or description of corporations or corporate taxation. Please see your attorney or tax professional for further details and the best entity for you. It is intended as just a brief overall description of the whats and whys of corporations and corporate taxation.