Business organizations can be structured in various ways, in terms of their structures as legal entities and also in terms of the internal structure and management processes. The corporation is one type of business structure. (Figure 1)
Compared to other business structures, such as sole proprietorships and partnerships, the corporation is less simple to found and maintain, one of its disadvantages. The incorporator must file articles of incorporation with the secretary of state’s office in the state in which it will be incorporated, as well as hold an organizational meeting to elect a board of directors. The structure also generally requires the maintenance of at least annual reporting. In many jurisdictions corporations, whose shareholders benefit from limited liability, are required to publish annual financial statements and other data, so that creditors who do business with the corporation are able to assess the creditworthiness of the corporation and cannot enforce claims against shareholders. Shareholders, therefore, experience some loss of privacy in return for limited liability. There is also the issue of double taxation, wherein the corporation is taxed on its profits and shareholders are also taxed on their earnings.
One of the most favorable advantages of the corporate structure is the protection of personal assets. Stockholders, directors, and officers of a corporation are typically not liable for the company's debts and obligations. They are limited in liability to the amount they have invested in the corporation. This limited liability also makes financing more attractive from a risk perspective. Also, because the corporation is an entity separate from its owners, ownership is easily transferable. Similarly, the corporation does not cease to exist with the death of shareholders, directors, or officers of the corporation. Another benefit of the corporate structure is that, in the United States, corporations are generally taxed at a lower rate than are individuals.
Best of Both Worlds: The S Corporation
S corporations are merely corporations that elect to pass corporate income, losses, deductions, and credit through to their shareholders for federal tax purposes. S status combines the legal environment of standard corporations with U.S. federal income taxation similar to that of partnerships. As with partnerships, the income, deductions, and tax credits of an S corporation flow through to shareholders annually, regardless of whether distributions are made. Thus, income is taxed at the shareholder level and not at the corporate level. Payments to S shareholders by the corporation are distributed tax-free to the extent that the distributed earnings were previously taxed. Also, certain corporate penalty taxes (e.g., accumulated earnings tax, personal holding company tax) and the alternative minimum tax do not apply to an S corporation.