Corporations: Formation and Organization

The creation of a corporation is usually more formal and technical than the creation of other forms of business organizations, and the operation of a corporation is usually more complex and regulated than other forms of business organizations. Are all of the formalities, technicalities, and regulations worth the benefits that a corporation can provide? Does it depend on the circumstances or the kind of business involved? If the usefulness of a corporation depends on circumstances or the kind of business involved, what circumstances would justify using a corporation to operate a business? What kind of business would justify a corporation?

Course Learning Outcomes for Unit VIII Upon completion of this unit, students should be able to:

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9. Analyze the operational aspects of corporations. 9.1 Discuss the characteristics of corporations. 9.2 Describe the requirements for formation of a corporation. 9.3 Compare the techniques for financing corporations.

 

Course/Unit Learning Outcomes

Learning Activity

9.1 Unit Lesson Chapter 22 Unit VIII Assessment

9.2 Unit Lesson Chapter 22 Unit VIII Assessment

9.3 Unit Lesson Chapter 22 Unit VIII Assessment

 

Required Unit Resources Chapter 22: Corporations: Formation and Organization

Unit Lesson

Corporations As we have seen, there are several forms for conducting a business, and each has its different characteristics and positive and negative consequences, but one form of doing business, the corporation, is significantly different from other forms of doing business. The primary reason that corporations are different from other forms of doing business and the characteristic that gives corporations their unique combination of characteristics is that corporations are considered to be separate legal entities. In other words, a properly formed corporation is a legal entity that is legally different from the people who own the corporation. There is no difference between a business operated as a sole proprietorship and the sole proprietor who operates that business. Partnerships can own business assets, but there is no legal difference between the people who are partners and the partnership itself. Limited liability companies begin to highlight the separation between the business operated by the limited liability company and the people who own the limited liability company, but the distinction between the organization that operates the business and the people who own the business is not clear-cut. A corporation and its owners, though, clearly fall into separate legal categories.

Limited Liability Since a corporation is a legal entity, it is responsible for its legal obligations, and the people who own the corporation, known as shareholders or stockholders, are not personally responsible for the legal obligations of the corporations and have at risk of loss only the amount that they paid for their ownership in the corporation. Shareholders in a corporation have limited liability. If a business will engage in activities that could create significant legal obligations, the owners of that business should seriously consider creating a corporation to operate that business. For example, if a business is being created to own and operate long-haul trucks that will carry hazardous cargo, that business should be operated by a corporation since the opportunities for

UNIT VIII STUDY GUIDE

Corporations

 

UNIT x STUDY GUIDE

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accidents that could be very serious are significant, and the owners of the business will not want to be personally responsible for the consequences of those accidents. Of course, the business will need insurance coverage to address potential liability, but since insurance does not often cover all of the legal consequences of accidents, the corporate form of doing business would protect the shareholders of the corporation from personal liability.

Income Taxes The status of a corporation as a legal entity separate from its shareholders also means that a corporation is responsible for its own income taxes. In a sole proprietorship, the income and expenses of the business are income and expenses of the sole proprietor, so the sole proprietor is responsible for whatever income taxes the sole proprietorship business owes. Partnership and limited liability companies are pass-through organizations for income tax purposes which means that whatever taxable income a partnership or limited liability company earns is taxable to the owners of the business organization, and the business organization itself has no liability for the taxes owned on that taxable income. Corporations, however, are not pass-through organizations, and the taxable income earned by the corporation is taxed to the corporation. Of course, though corporations are considered to be legal entities, they cannot physically do anything and must act through employees who function as their agents. Employees of a corporation include those who keep up with the financial transactions of the corporation and compute the taxable income of the corporation, but those employees are not personally liable for the taxes that the corporation owes.

Double Taxation The fact that corporations are responsible for the income taxes that they owe results in one of the primary disadvantages of using the corporate form of doing business—double taxation. When the income tax liability of a corporation is calculated, the allowable expenses incurred by the corporation are deducted from the income received by the corporation, and the result is the taxable income of the corporation, and the corporation pays income taxes on that taxable income. One of the reasons that people own interests in corporations is that when corporations are profitable, they often pay some of those profits to their shareholders in the form of dividends. Dividends paid by a corporation are not considered to be expenses that can be deducted from the corporation’s income in determining the corporation’s taxable income, so when a corporation pays dividends to shareholders, those dividends are paid from funds that have already been taxed. When dividends are received by a shareholder, those dividends are considered to be taxable income to the shareholder, so the shareholder must pay income taxes on those dividends. Therefore, money paid by a corporation to a shareholder as a dividend has been taxed once at the corporate level and again at the shareholder level, resulting in the double taxation of corporate dividends. Strategies have been developed to avoid or reduce the burden of double taxation of corporate dividends. For example, certain corporations can qualify under federal tax law as S Corporations so that the corporation is not taxed and its taxable income is passed through to the shareholders as it would in a partnership, but the restrictions that apply to Subchapter S Corporations can make them an unattractive form of doing business.

Sale of Shares in a Corporation Ownership in a corporation is evidenced by stock certificates which are documents that indicate the name of the shareholder and the number of shares or percentage ownership of the corporation that is represented by the stock certificate. Unless the corporation or some provision of law imposes restrictions on the sale of the shares of stock that a shareholder owns, a shareholder is free to sell their shares in the corporation whenever they chose and for whatever price they want. If the corporation is large enough, the stock of the corporation may be bought and sold on an organized stock exchange such as the New York Stock Exchange (NYSE) where the price of the stock is established periodically through multiple sales and purchases of the stock. If the stock of a corporation is not bought and sold on an organized stock exchange, purchase or sale of the stock can still be arranged by negotiated sale. Whether the stock of a corporation is bought and sold on a stock exchange or through a negotiated sale, one of the advantages of the corporate form of doing business is that owners of the corporation can sell their interests in the corporation when they decide that either they no longer want to own an interest in the corporation or they decide to move their investment to another business. Though the owners of the corporation may change, the change in ownership does not impact the corporation, and the corporation continues to exist.

 

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Formation of Corporations Corporations are creatures of state law. That is, a corporation is properly formed by satisfying the requirements of the law of the state where the corporation is to be formed. While the requirements for forming a corporation vary from state to state, the requirements are similar in most states. Formation of a corporation begins with the selection of a name and the reservation or approval of that name by the state office where corporations are registered. That is a mechanical process, but the name selected must not be the same as or similar to the name of a corporation already formed in the state, and the name of the corporation must contain the word corporation, corp, incorporated, inc., company, or co. The people who actually undertake the activities necessary to form a corporation are called incorporators and usually become the shareholders of the corporation. When the name of the corporation has been selected and approved by the state, the incorporators have articles of incorporation prepared, usually by a lawyer. State law establishes the information that must be included in the articles of incorporation, and, in addition to the name of the corporation, the articles of incorporation usually include the nature of the business that the corporation will conduct, the registered office of the corporation, how many shares of stock the corporation can issue, and the names and addresses of the initial directors of the corporation. While all of this information must be included in the articles of incorporation, all of the information can be changed by filing the appropriate forms with the state office where corporations are registered. Formation of a corporation also requires the creation of by-laws for the corporation, which detail how the corporation will be managed, by whom the corporation will be managed, and how major decisions affecting the corporation will be made.

Financing a Corporation There are specific roles that have to be fulfilled in the creation and operation of a corporation. As indicated above, the people who actually form the corporation are the incorporators whose roles are completed when the corporation has been formed and who usually become the first directors of the corporation. Once the corporation is formed, it will sell stock to raise funds for the operation of the business, and those who buy stock in the corporation are the shareholders. In addition to having a right to receive dividends paid by the corporation, shareholders have other rights with respect to the corporation. For example, each shareholder has a right to vote for directors of the corporation, so after the terms of the initial directors of the corporation have expired, the shareholders vote to either allow existing directors to continue to serve or to elect new directors. Directors are responsible for setting the overall strategy and direction of the corporation and have a responsibility to the corporation and the shareholders of the corporations to exercise good judgment based on adequate knowledge in directing the activities of the corporation. Directors are also responsible for hiring the management team for the corporation which usually consists of at least the chief executive officer (CEO) or president and top vice presidents of the corporation. When a corporation sells stock to finance the operations of the corporation, the corporation may—but is not required to—share the corporation’s profits with shareholders by paying dividends, and the corporation may— but is not required to—buy stock back from shareholders. Therefore, a shareholder is considered to be an owner of an interest in the corporation and to have made an equity investment in the corporation. In many instances, the money raised by a corporation through the sale of stock is not enough to fund the operation and possible expansion of the corporation’s business, so the corporation may consider borrowing additional funds. Of course, a corporation might simply obtain a loan from a lender that will be paid back in periodic payments of principle and interest, but corporations can also sell bonds to raise capital. A bond is a debt instrument, which is purchased by someone and which promises to pay the purchaser a specific amount of interest periodically and then to repay the purchaser the purchase price of the bond at a specific time in the future. Corporations are efficient ways to operate a business, but before forming a corporation, business owners should consider the benefits offered by corporations and the burdens of the corporate form of doing business.

 

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Suggested Unit Resources In order to access the following resource, click the link below. Winkler, A. (2018). Bank of the United States v. Deveaux and the birth of Constitutional rights for

corporations. Journal of Supreme Court History, 43(3), 237–256. https://libraryresources.columbiasouthern.edu/login?url=http://search.ebscohost.com/login.aspx?direc t=true&db=31h&AN=133235938&site=ehost-live&scope=site

 

Learning Activities (Nongraded) Nongraded Learning Activities are provided to aid students in their course of study. You do not have to submit them. If you have questions, contact your instructor for further guidance and information.

 

View the Unit VIII Glossary to review key terms presented in this unit. Alternate format for Unit VIII Glossary

 

Reference Photogl. (n.d.). Books on library shelves (ID 20785201) [Photograph]. Dreamstime.

https://www.dreamstime.com/stock-image-books-library-shelves-image20785201

(Photogl, n.d.)

 

  • Course Learning Outcomes for Unit VIII
  • Required Unit Resources
  • Unit Lesson
    • Corporations
    • Limited Liability
    • Income Taxes
    • Double Taxation
    • Sale of Shares in a Corporation
    • Formation of Corporations
    • Financing a Corporation
  • Suggested Unit Resources
  • Learning Activities (Nongraded)

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