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Ashley is an attorney. She has taught and written various introductory law courses.
One of the oldest and most popular business structures is the corporation. A corporation is a complex business structure, subject to many rules and laws. It's a business entity that is completely separate from the individuals that run the business.
This means that a corporation is, essentially, a legal person. The corporate person is separate from its shareholders, directors, officers and employees. Note that the owners of a corporation are known as shareholders. The shareholders each hold stock in the corporation.
Like any other person, a corporation has certain legal responsibilities. A corporation can sue and be sued. It can make contracts and is liable for those contracts. It can commit a crime or even be the victim of a crime. Corporations can even own property.
The corporate structure has several unique attributes. Corporations and shareholders are subject to double taxation, but shareholders enjoy limited liability. However, corporate advantages aren't absolute. Corporations must follow strict rules or the corporate veil will be pierced. Let's take a separate look at these corporate attributes.
The main disadvantage of a corporation is that the business is separately taxed on its profits. This tax treatment differs from partnerships or sole proprietorships.
Since corporations are considered to be a separate legal entity, that entity is subject to taxes just like other individuals. Ultimately, this leads to double taxation because income taxes are paid twice on the same source. Keep in mind that the corporation's profits become the shareholders' salaries, bonuses and dividends. This means that business profits are taxed as earned income both when received by the corporation and also when passed on to the shareholders.
Now let's look at an advantage provided by the corporate structure. The main advantage of a corporation is that it provides shareholders limited liability. Since the corporation is an independent entity from the shareholders, the corporation is held legally liable for its own business debts, taxes, liabilities and other obligations. The shareholders enjoy limited personal liability for the financial obligations of the business.
This means that the shareholders generally can't be held personally liable for the corporation's contracts, debts, court judgments or any other financial obligation of the corporation. Because only corporate assets can be used to pay the corporation's liabilities, each shareholder risks losing only the amount of money that shareholder invested in the corporation. This doctrine serves to protect the shareholders' personal assets, like cars and houses.
Limited liability, however, is not absolute. There are several circumstances in which limited liability won't apply. A shareholder can be held personally liable if the shareholder:
For example, let's say that Carla is a shareholder in Company, Inc. Carrie is the president at Company, Inc. and Carla's best friend. Sadly, Company, Inc. isn't doing very well. Carrie fears the business might be forced into bankruptcy in the next few months. Carrie says the business needs money to pay bills, but she can't get a business loan because Company, Inc. has bad credit. Carrie asks Carla to guarantee a loan for Company, Inc.
Carla co-signs the business loan, but unfortunately, Company, Inc. goes out of business anyway. When the bank tries to collect on its loan, Carla won't be able to claim the protection of limited liability. Carla's personal assets can be seized in order to pay back the loan.
Note also that shareholders can be held personally responsible for the corporation's liabilities if the shareholders fail to treat the corporation as a separate legal entity. The result is known as piercing the corporate veil and can occur by court order when one or more shareholders treat the corporation as personal property.
A court can order that the corporation fails to exist as a separate entity, thereby subjecting the shareholders to personal liability. The corporate veil can be pierced, or broken, when the shareholders fail to keep a strict separation between the company and its shareholders. Common piercing acts include the failure to:
For example, let's say that Carla's family owns Company, Inc. It's a private company, and the only shareholders are Carla and her extended family. Carla regularly pays her personal credit card bills using the business checking account. Her family knows and doesn't mind.
However, a client recently slipped and fell at Company, Inc. headquarters. The client sued the business and received a large damages award. Carla and her family might be held personally liable for the award since they failed to keep a formal legal separation between Company, Inc. and their personal financial affairs.
Let's review. A corporation is a complex business structure that is completely separate from the individuals that run the business. This means that a corporation is a legal entity separate from its shareholders, directors, officers and employees.
This separation means that the corporation is subject to double taxation. The corporation's profits are taxed. These profits become the shareholders' salaries, bonuses and dividends. The shareholders must then pay tax on that income.
The separation also means that shareholders have limited liability for the corporation's business debts, taxes, liabilities and other obligations. The shareholders generally can't be held personally liable for the financial obligations of the business.
However, shareholders can be held personally responsible for the corporation's liabilities if the shareholders fail to keep a formal legal separation between the corporation and their personal financial affairs. This is known as piercing the corporate veil.
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Back To CourseBusiness Law Textbook
23 chapters | 177 lessons