S Corporations
One of the most widely used, second only to the sole
proprietorship, is the S corporation; what is the S corporation
and how does it work? Let's attempt to answer those questions in
the next few paragraphs.
The definition of a corporation is an organized form of business
in which the ownership of the business is held by stockholders,
or shareholders-individuals who have purchased ownership shares
in the business. The corporation is organized with a board of
directors and officers. The board of directors is elected to
make the business decisions that affect the overall business
condition and financial health of the business. Officers are
elected to oversee the day-to-day operations of the business.
The advantages of operating a business as an S Corporation are
first, that your liability is limited, second, it is a perpetual
legal entity, and third, the S corporation can raise money by
selling shares of stock to corporate investors. What does all
this really mean? The limited liability aspect works in this
manner: you are only liable to the extent of your investment. If
you've only invested $5000 in a business, you are only liable
for the value of the investment or $5000. The fact that a
corporation is a legal entity and is perpetual means that even
if one officer, board director, or shareholder should die, the
business continues, often quite successfully. The ability to
raise money is perhaps one of the best advantages. Many times, a
business will need to increase cash flow, or fund the purchase
of new equipment; if you can sell shares in the business, you
have a built in way to fund those needs.
There are however certain qualification requirements for an S
Corporation; they are as follows: the corporation must be a
domestic corporation; the corporation must not be a member of an
affiliated group of corporations; the shareholders of the
corporation must be individuals, estates, or certain trusts.
Partnerships and nonqualifying trusts cannot be shareholders.
Under certain circumstances, corporations can be shareholders;
the corporation must have seventy-five or fewer shareholders;
the corporation must have only one class of stock, although not
all shareholders need to have the same voting rights, and no
shareholder of the corporation may be a nonresident alien.
Although these may seem like difficult requirements to meet,
they really are not. Most of them are taken for granted by many
business owners in their attempt to form a corporation, so
commonplace are the requirements. The only requirement that is
today posing a problem is the requirement that all shareholders
be citizens, not nonresident aliens. This interprets into a
problem if say, a European investor wants to buy stock in an S
corporation, and it currently is not permitted. However, as we
operate on a more global basis, we may see a change in this
requirement.
The disadvantages to the S corporation lie in the restriction on
the number of shareholders and the fact that the corporation
must not be a member of an affiliated group of corporations.
Sometimes, the S corporation grows to the point that more than
seventy-five shareholders is a feasible reality, and the
corporation could be bought as a subsidiary, except that this
changes the S Corporation status; it must now re-organize its
legal entity status.
In forming a corporation, there are some legal requirements that
must be met, before a corporation is legally recognized in the
state it has chosen as it's state of incorporation; a name must
be reserved and approved, articles of incorporation must be
filed with the state and with your county clerk's office, and
board members, officers, and stockholder shares must be
completed. Once the corporation is organized, then the Board of
Directors will put together the Bylaws that will govern many of
the actions that the Board may execute, and what is expected
from the officers, and the day-to-day operations of the
business.