Taxes Made Simple

The essential thing to know about corporations is that, for legal purposes, they are distinct entities. In other words, corporations are treated (more or less) as if they were people. They’re allowed to own things, rent things, sue or be sued, and so on.

Limited Liability

The reasoning behind the concept of the corporation—a business legally distinct from its owners—was to allow the owners to not have to worry about being held personally liable for the debts of the business. Generally speaking, because the corporation is a separate entity, anybody wishing to bring a lawsuit against the business has to bring it against the corporation rather than against the owners personally.

This protection is in fact one of the fundamental elements of our entire economy. For example, what are the odds that anybody would have invested in PepsiCo™ if they knew that they could be held personally liable if anybody were to bring a lawsuit against the company as a result of getting sick from one of their products? If corporations didn’t offer the protection they do, hardly anybody would invest in new companies.

Planning on Outside Investment? Plan on Incorporating.

For the above-mentioned reason, if you’re planning on securing cash from outside investors, it’s quite likely that your only option is going to be to form a corporation. (To be more specific, it’ll likely have to be a C-corporation due to S-Corporation ownership restrictions, which we’ll discuss in Chapter 13.)

Another reason that investors are far more likely to invest in a corporation is that shares in a corporation can be sold far more easily than can ownership interests in any other structure of business. Investors like knowing that if they want to get out, they can.

Ongoing Legal Requirements

One slight drawback to forming a corporation is that there are a few ongoing legal requirements that will take up your time. For example, whenever the directors of a corporation make a major decision, most states require it to be recorded in a document known as a “resolution.” A resolution doesn’t have to be anything fancy or complicated. Just be aware that forming a corporation means you’re going to be in for a little more paperwork.

Also, most states require an annual meeting of the directors and shareholders of the corporation, as well as a record of what was discussed at the meeting. Of course, if you’re the only owner, this basically just comes down to preparing one more document every year, as the “meeting” with yourself probably doesn’t have to be very long.

“Piercing the Corporate Veil”

Whenever you read anything about the limited liability provided by the corporate form, you’re also going to hear at least a mention of the term “piercing the corporate veil.” This term refers to the fact that, on occasion, a court may decide that a corporation is not materially separate from its owners, and that the plaintiff should be allowed to come after the owners for their personal assets.

Some of the things that may lead a court to pierce the corporate veil include:

1. Intermingling of funds between corporate accounts and personal accounts of the owners,
2. Disregard for corporate formalities (such as the preparation of resolutions and holding of annual shareholder meetings),
3. Absence of corporate financial records, and
4. Anything else that would lead a court to believe that the corporation is merely a formality, and is not materially distinct from its owners.

Generally, the best thing you can do to prevent such an occurrence is to keep excellent records for the corporation. The most important records to make sure to keep are those detailing any transactions between the corporation and its owners.

Simple Summary

• Generally speaking, the owners of a corporation will not be able to be held personally liable in the case of a lawsuit against the corporation.
• If you plan on attracting outside investors, you’ll likely have to form a C-corporation.
• Major decisions made by the directors of a corporation are required to be documented in a corporate resolution.
• The directors and owners of a corporation are required to have a documented meeting every year.
• If a court decides that a corporation is not in fact distinct from its owners, the court may decide to “pierce the corporate veil,” thereby allowing a plaintiff to come after the involved shareholders’ personal assets.
• The best thing you can do to prevent a court from piercing the corporate veil is keep excellent records, especially for transactions between the corporation and its owner(s).

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A Testimonial from a reader on Amazon:

"A very concise and practical guide to the formation, taxation and legal differences between Sole Proprietorships, Corporations and everything in between. Very easily read with a simplified presentation makes this a great introduction to help you decide how to form your business." - Michael J Reed

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