What is a Corporation?  A corporation is a legal entity that exists separate and distinct from its owners. A corporation may sue and be sued, can own property, enter into contracts, and conduct business under its own name.  Creation of a corporation occurs when properly completed articles of incorporation (called a charter or certificate of incorporation in some states) are filed with the proper state authority, and all fees are paid.

What is the difference between a corporation and a Limited Liability Company (LLC)?  Both corporations and LLCs offer limited liability to its owners. A corporation may exist in perpetuity while an LLC must have a definite lifespan (usually no more than 30 years). An LLC may elect to be taxed as a partnership rather than as a corporation (passing all the income and losses through to its owners). The LLC has an advantage over a “C” corporation, a regular corporation that makes an “S” corporation tax election because the S corporation can only have 75 stockholders and the stockholders cannot be corporations or non-U.S. citizens.

What is the organizational structure of a corporation?  The organizational structure of a corporation consists of three basic groups: shareholders, directors, and officers.  A corporation is owned by shareholders. Shareholders do not directly manage the corporation. Instead, they influence corporate decisions through indirect methods such as electing and removing directors, approving or disapproving amendments to the articles of incorporation and voting on major corporate issues.  The board of directors is responsible for managing the affairs of the corporation. Usually, directors make only the major business decisions and supervise and appoint the officers who make the day-to-day business decisions of the corporation.  Officers are responsible for the everyday management of the corporation. Typically, officers are appointed directly by the board of directors.  In Arizona, for-profit corporations require at least two persons. The same person cannot be the President and the Secretary, although one person may be the sole shareholder, the sole director and the President or Secretary. One person may hold more than one office so long as it is not the office of President and Secretary.

How many directors do I need to form a corporation?  In Arizona, only one (1) director is required for corporations. More than the minimum number of directors may be used. It is often a good idea to have an odd number of directors, in order to break any tie vote. A person may be a director and simultaneously be a stockholder and hold one of the corporate offices.

What is an S corporation?  Standard business corporations or “C” corporations are required to pay income tax on taxable income generated by the corporation. Making a Subchapter “S” election by completing and filing federal form 2553 with the IRS (within the limited time allowed by law) is a way to avoid having a corporation treated as a separately taxable entity.  An “S” corporation is a standard business corporation that has elected a special tax status with the IRS. This tax treatment allows the corporation not to be a separately taxable entity. Instead, the income of the corporation is treated as the income of a partnership or sole proprietorship; the income is “passed-through” to the shareholders. Thus, shareholder’s individual tax returns report the income or loss generated by an “S” corporation.  To be classified as an “S” corporation, a corporation must make a timely filing of Form 2553 to the IRS. This election must be made by March 15 if the corporation is a Calendar year taxpayer in order for the election to take effect for the current tax year. A corporation may later decide to elect “S” corporation status, but this decision would not take effect until the following year.  In order to qualify for “S” corporation status, the corporation must be a U.S. corporation with only one class of stock and the shareholders must number fewer than 75. These shareholders must be individuals, estates or certain qualified trusts, who consent in writing to the “S” corporation election. The shareholders can not be non-resident aliens.  The primary advantage of an “S” corporation is the avoidance of double taxation. That is, the avoidance of payment of income tax on corporate net income, and then the payment of a further tax on the dividend income that is derived from the corporation. Thus, an “S” corporation allows certain income, deductions, and losses to be passed through the “S” corporation to the individual tax return of each shareholder.

What are the advantages of incorporation?  A corporation protects the owner of a business against personal liability. A primary advantage of incorporation is the limited liability the corporate entity affords its shareholders. Typically, shareholders are not liable for the debts and obligations of the corporation; thus, creditors will not come knocking at the door of a shareholder to pay debts of the corporation. In a partnership or sole proprietorship, the owner’s personal assets may be used to pay debts of the business.

Other advantages:

A corporation’s life is not dependent upon its members. A corporation possesses the feature of unlimited life. If an owner dies or wishes to sell their interest the corporation will continue to exist and do business.

Retirement funds, qualified retirement plans (like 401k) may be set up more easily with a corporation.

Ownership of a corporation is easily transferable.

Capital can be raised more easily through the sale of stock.

A corporation possesses centralized management.

What are the disadvantages to incorporation?  The primary disadvantage to a corporation is double taxation. Profits of a corporation are taxed twice when the profits are distributed to shareholders as dividends. They are taxed first as income to the corporation, then as income to the shareholder. All reasonable business expenses such as salaries are deductions against corporate income and can minimize the double tax. Further, the double tax can be eliminated by making an “S” corporation election.

Other disadvantages:

Complexity and expense of forming a corporation.

Extensive record keeping requirements.

Operating a corporation across state lines requires the corporation to qualify to do business in the other state.

What paperwork is required to incorporate?  Articles of incorporation conforming to state law must be prepared and filed with the proper state authorities and filing fees must be paid. Once the Arizona Corporation Commission has approved the articles of incorporation, the articles must be published for a certain number of times in a certain type of newspaper (a newspaper of general circulation) in a certain county. Minutes of the organizational meeting must be prepared, stock certificates must be issued and often it is a good idea to have a written shareholder’s agreement.

What is a Statutory Agent?  Also known as a registered agent, a statutory agent is a person or company appointed by the Corporation to receive legal notices and documents and to receive service of process. Service of process is the act of serving someone with legal papers such as a subpoena, a summons, a complaint, a petition or other documents involved in a lawsuit. In Arizona, the statutory agent must be a resident of the state for at least three years.

Do I need an attorney to incorporate?  No, an attorney is not a legal requirement to incorporate. You can prepare and file the articles of incorporation yourself; however, if you are going to do it right you should be thoroughly versed in Arizona law, in corporations law, in securities law, in contract law and in other areas of the law affected by the corporation’s business.

What name should I use?  Choose a name carefully. It is important to portray the proper image for the corporation. The name must be “distinguishable” from other Arizona entities.  Additionally, the name must show that the business is incorporated. The word “Corporation,” “Incorporated,” “Limited,” “Company” or an abbreviation must follow the corporate name.  For more information about Arizona corporate names, read the Arizona Corporation Commission naming standards.

How do I start?  Articles of Incorporation must be filed with the state government and initial fees must be paid. After Articles are filed, the corporation must hold an organizational meeting where bylaws are adopted and the incorporation process is completed. The corporation must be properly capitalized. Share certificates must be distributed to shareholders and these transactions should be recorded on the corporation’s stock ledger. All of this information should be kept in a corporate record book.

Note: Arizona law changes from time to time.  This article may not be consistent with current Arizona law.  Therefore, always check the statutes and case law before using the information in this article.

Fair Street office