To create a corporation means to create an artificial “person.” For legal and tax purposes, a corporation is a separate entity from its owners. A corporation may make purchases, enter into contracts, pay taxes, and sue and be sued.
Corporations must be established in compliance with the requirements set forth in Texas law. The shareholders are the owners of the corporation. Management and control of the corporation are the responsibility of the board of directors, whose members may or may not be shareholders. The income, expenses, and losses of the business are filed on the corporation’s tax returns.
5 Steps to Incorporation:
Filing of the Certificate of Formation
Payment of Fees
Funding of the Corporation
Organizational Meeting of Directors
Issuance of Shares
The benefits of a corporation include protecting the shareholders from business debts and responsibilities in most cases. Unlike the business options previously discussed, a corporation’s creditors may not seek to collect debts from the owners of the corporation. However, owners of a new corporation may be required by financial institutions to give personal financial assurances in order to receive funding. There is continuity of a corporate business regardless of individual shareholder status. Even if several shareholders sell their shares in a business or a principal stockholder dies, the corporation’s existence is not affected. Also, a corporation may sell stock or shares in its business to raise capital. Corporations may have several types of stocks or shares available, such as voting shares and nonvoting shares.
The drawbacks of a corporation include double taxation. The corporation files its own tax returns and pays taxes on its profits before paying dividends to the shareholders. When the shareholders receive the dividends, these profits must be included on their individual federal tax returns.
An S corporation derives its name from a section of the Internal Revenue Code. Under Subchapter S of the Code, a corporation that meets certain requirements may be treated as a corporation for liability purposes but treated as a partnership for taxation purposes. Shareholders of an S corporation receive limited liability protection, and their profits from the business are included on their individual federal income tax returns. Although Texas does not have an income tax, corporations, including S corporations, are subject to a franchise tax that operates as a form of income tax. A corporation that is treated as an S corporation for federal tax purposes may receive similar treatment in the calculation of its franchise tax in Texas.
The requirements of an S corporation include:
– No more than 35 shareholders
– Shareholders must be natural persons (not corporations or partnerships)
– Shareholders cannot be nonresident aliens
– One class of stock
After a business has incorporated, all shareholders must consent to Subchapter S treatment. The election to be treated as an S corporation must be filed with the Internal Revenue Service in a timely manner.
In order to be considered nonprofit, a corporation must have been formed for a purpose other than the financial benefit of its shareholders. Also, a nonprofit corporation cannot pay any dividends or other financial rewards to its shareholders. There are specific Texas laws for nonprofit corporations. To receive tax- exempt status, an organization must first incorporate as a nonprofit corporation. After incorporation, applications for tax- exempt status must be filed with the Internal Revenue Service and the Texas Comptroller of Public Accounts. In order for contributions to the organization to be tax deductible, other requirements must be met. Certain charitable organizations also may face additional requirements. Additional information about nonprofit corporations can be found in the Associations & Nonprofit Corporations Law Chapter.