Corporations PDF Print E-mail

The corporation is the dominant form of business ownership today. California general business corporations are governed by the General Corporation law [Corp. Code § 100 et seq.]. A corporation is a distinct legal entity, existing apart and recognized separately from its owners or shareholders, and has all the powers of a natural person, including the rights to own property, sue in its corporate name, and make contracts [Corp. Code § 207]. Under California law, a corporation may be formed to engage in any business activity, subject to compliance with applicable laws [Corp. Code § 206]. The rights and obligations of the corporation, its directors, and its shareholders are clearly delineated by law but may be altered, within statutory limits, by agreement [Corp. Code §§ 300-318, 600-605, 700-711].

The formation and operation of a corporation, like a limited partnership, requires more formality than does the formation and operation of a sole proprietorship or a general partnership. A corporation is chartered by the state andmay be formed only by filing articles of incorporation with the Secretary of State [see Corp. Code §§ 200-210]. Owners of a corporation ordinarily are issued shares, signifying their ownership interests [see Corp. Code § 400]. However, shareholders do not participate in the daily management of the corporation; their participation is limited to electing the corporate board of directors and voting on a limited number of significant transactions [Corp. Code § 700(a)]. A corporation is controlled by a board of directors, who have the discretion to appoint officers to manage the day-to-day business [Corp. Code § 300(a)].

In General

Despite wide variations within the corporate form, all corporations share certain basic characteristics, including the following: (1) management and control by a board of directors and officers appointed at the board's discretion; (2) limited personal liability; (3) greater availability of capital than generally exists for noncorporate business forms; (4) perpetual life; and (5) taxation as a separate entity, unless the corporation has elected to be taxed under Subchapter S of the Internal Revenue Code [see [b]-[f], below].

Management and Control

A corporation is under the control of its board of directors and is managed either by the board or, as is usually the case, by officers appointed by the board [Corp. Code § 300(a)]. In publicly held corporations, whose stock is sold to the public at large, shareholders do not participate in corporate management [Corp. Code § 700(a)]. However, the purpose of a close corporation is to allow the shareholders to do just that, to participate in the day-to-day management of the corporation, without losing the protection of the corporate form [see Corp. Code § 300(e)].

Extent of Personal Liability

The most significant feature of a corporation (as of a limited partnership or limited liability company) is its protection from personal liability. If properly formed and operating, a corporate shareholder's liability is limited to the amount of the investment in the corporation.

Further, because a corporation is a separate legal entity, its directors, officers, and employees ordinarily do not have any personal liability for the corporation's debts or other obligations [see Corp. Code § 300(d)]. Neither are they generally liable for the torts or criminal acts of one another, although directors, officers and other employees may be liable to the shareholders for a breach of their defined duties to the corporation [see Corp. Code § 300].

This limited liability protection distinguishes the corporate form from the sole proprietorship and from the general partnership (other than a limited liability partnership [see § 1B.15[5]]), and is similar to the protection from personal liability enjoyed by limited partners in a limited partnership. However, unlike shareholders, limited partners risk exposure to personal liability by participating in the management and control of the business [Corp. Code §§ 15632(a), 15903.03].

Availability of Capital

Corporations generally provide the most flexible vehicle for obtaining capital. As with sole proprietorships and partnerships, financing is available through unsecured loans and loans based on the credit or personal guarantees of the directors, officers or shareholders or secured by the business's assets. In addition, capital is available through the sale of equity interests in the corporation. Because of limited liability for the debts and other obligations of the corporation, as well as the wide variety of types of capital interests, corporate shares often appeal to investors. As a practical matter, however, sale of securities is often limited to those offered by publicly held corporations (that is, corporations whose stock is sold to the public at large); and small or newly established corporations may be able to obtain financing only with the personal guarantees of their owners.

Like limited partnership interests, corporate securities are regulated by federal and state securities laws [see Corp. Code §§ 25000-25706; see also 15 U.S.C. §§ 77a-77aa], unless the securities qualify for an exemption [15 U.S.C. § 77c(a); Corp. Code § 25102(f), (h)]. For a comprehensive discussion of corporate securities, see Chs. 6 through 6J.For a detailed guide to securities regulation, see Ch. 6, Securities Regulation Issues .

Continuity of Existence

A corporation has perpetual existence, unless its articles of incorporation state otherwise [Corp. Code § 200(c)]. A corporation does not terminate on the death or change of identity of its shareholders, although the death of the sole shareholder of a professional corporation may, in effect, result in the practical, if not the legal, termination of the corporation.

Taxation

A regular or general corporation is a separate tax paying entity for federal and state tax purposes [I.R.C. § 11; Rev. & Tax. Code §§ 23038, 23151], unlike sole proprietorships [I.R.C. §§ 61(a), 62(a)(1)], general and limited partnerships [I.R.C. § 701], most limited liability companies [see I.R.C. § 701], and Subchapter S corporations [I.R.C. § 1361(b)]. A regular corporation is referred to as a ''C'' corporation in the Internal Revenue Code, to distinguish it from an ''S'' corporation, a corporation that has elected to be taxed under Subchapter S of the Internal Revenue Code [I.R.C. § 1361(a); see I.R.C. §§ 1361-1366]. See § 1B.31[4] for a discussion of taxation of S corporations. A corporation formedunder state law is a corporation for income tax purposes [see Treas. Reg. § 301.7701-2(b)]. California taxation of corporations generally conforms to federal taxation [Rev. & Tax. Code § 23051.5]. For a detailed discussion of corporate taxation, see Ch. 1E, Taxation of Businesses .

A C corporation is subject to a corporate tax rate schedule, which applies graduated rates that differ from the individual income tax rate schedule [I.R.C. § 11(b)]. However, certain personal service corporations are not eligible to use the graduated rates and are, instead, taxed at a flat rate [I.R.C. §§ 11(b)(2), 448(d)(2); see § 1B.31[5]].

Corporations are subject to double taxation. A corporation's profit is taxed once to the corporation, and again when the after-tax profit is distributed to the shareholders as dividend income [see I.R.C. §§ 301, 316], unless the shareholder is a corporate entity eligible for the dividends-received deduction [see I.R.C. §§ 243(a)(1), (b), (c), 248]. Double taxation of dividends is less of a concern during years in which dividends are taxable at lower capital gains rates (generally tax years beginning after December 31, 2002, and before January 1, 2009), but still is a notable corporate characteristic [I.R.C. § 1(h)(11); see Pub. Law No. 108-27, §§ 302(f)(1), 303 (effective date and sunset provisions for dividend taxation at capital gains rates)]. Corporate losses may be deducted from corporate income only by the corporation; such losses are not deductible by the shareholders on their individual income tax returns [see I.R.C. § 11]. A shareholder recognizes capital gain or loss on the sale of shares of stock or on the liquidation of the C corporation [I.R.C. §§ 302, 331].

 

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