Corporate ownership is one of three broad categories of legal ownership of a business, the other two being sole proprietorship and partnership. In a sole proprietorship, the owner is personally liable for his or her business's debts and losses, there is no distinction made between personal and business income, and the business terminates upon the death of the owner (unless some specific arrangement is made for someone to inherit the business). A partnership is merely joint ownership, and hence, in terms of personal liability, it is similar in every way to a sole proprietorship. Both categories of business ownership are simple arrangements that can be entered into and dissolved easily, without even a written contract, sometimes merely by shaking hands.
Corporate ownership, on the other hand, is much more complex, because it involves the creation of a legal identity separate from those of its owners. While an individual may own all the shares of a corporation, he or she is not personally responsible for it. That is because a corporation is, strictly defined, a legal entity that is "immortal" (does not terminate upon the owner's death), which can enter into and dissolve contracts, incur debts, sue or be sued, own property and sell it, as any individual may do.
The corporation is rooted in medieval European history. Long before there were viable urban centers in Western Europe, monastic orders existed independently of their membership. All assets belonged to the order, rather than to the individual member. Monastic orders and, eventually, universities and towns, became the earliest forms of corporations. By the High Middle Ages, corporations had become so widespread that their status needed legal definition. In the 15th century, English high courts elaborated a legal principle inherent in all corporations: limited liability. Henceforth, creditors of a bankrupt corporation could not sue individual owners of corporate stock for the recovery of debt, the corporation being solely responsible for losses. Hundreds of years later, the U.S. Supreme Court refined the status of corporations still further. In Santa Clara County vs. Southern Pacific Railroad in 1886, the Court ruled for the first time that a corporation was a legal person, with the same rights, privileges, and responsibilities.
Corporate ownership has evolved over the centuries to the point where, today, there are several major types. Private, for-profit corporate ownership characterizes the majority of present-day corporations. Most of these are general business or C corporations. These can determine whether corporate profits are paid out to stockholders (or, as the case may be, to the sole stockholder), or remain with the corporation. Many artists and other professional people, however, prefer to file for S corporation status, where "S" stands for small business, in which profits go entirely to the individual shareholders (or sole shareholder) as personal income, and are taxed as such. By definition these are among the smallest corporations and must observe several restrictions in order to maintain their S status.
Other major categories of corporate ownership are public, quasi-public, nonprofit, and foreign. A public corporation (not the same as a publicly traded corporation) is created solely for government purposes, as, for example, a school district. Quasi-public corporations are not established with the sole purpose of carrying out government objectives, but they do serve the same clientele, namely, the general public. Utility companies are the most prevalent type of quasi-public corporation. A nonprofit corporation is established for charitable purposes, rather than for the purpose of making a profit or serving a public need. Hence while private nonprofit corporations can and often do generate profits, these profits are not taxed and are reinvested in the corporation, distributed back to the membership, or donated to other charities. "Foreign corporation" can refer to two kinds of entities: (1) a business incorporated in one state that is doing business in another, where it is said to be "foreign"; or (2) a corporation owned by a non-U.S. entity. For the most part, corporations controlled by a non-U.S. owner are treated the same under the law as those that are domestically held.
Because all categories of corporations enjoy limited liability—stockholders can never lose more than they have invested in the corporation, and they are not liable for any of the corporation's debts—they have become the most prevalent business organization in the United States, Europe, and Japan. For the self-employed person in the United States, a compelling reason for turning a sole proprietorship into a corporation has been the opportunity to qualify for workers' compensation, and to obtain full health coverage (the entire cost of which can be claimed as a business expense). In all countries where corporate ownership is legal, corporate taxes are significantly lower (30-50 percent) than for a sole proprietorship. Similarly, complete exemption from federal, state, and local taxes is the prime incentive for establishing a nonprofit corporation.
The process of incorporation, either for a sole incorporator or a group of people, is an uncomplicated one. All corporations are registered at the state level. The process begins by choosing a corporate name that is not duplicated by any other corporation, and complying with the state's filing requirements. All states require an employer identification number, and the filing of articles of incorporation, the contents of which may vary from state to state. The articles of incorporation establish the company's name, the purpose of forming the company, the number and amount of the company's authorized stocks, the resident agent's name and address, and the name and address of any other corporate officer. Most but not all states require that the filer show evidence of an organizational meeting (such as a copy of the minutes). Only after the articles of incorporation are filed and accepted in the appropriate state, do corporations acquire legal existence.
Usually a small incorporation fee is required, and in some states a minimum corporate tax must be paid in advance. Virtually all states levy corporate income taxes, as well as sales and other taxes. In addition, there is a federal corporate income tax, which is usually a flat-rate amount instead of a graduated tax. The exception is the excess profits tax, which is graduated and based on the amount of invested capital rather than on earned profits. Since 1981, federal tax legislation affecting corporations has been passed annually.
Some states are regarded as having incorporation laws that are more favorable than others. The traditional choice for those seeking incorporation has been Delaware, for reasons outlined below, although legal reforms in many states have eliminated several of Delaware's advantages. Various estimates suggest that still more than half of major U.S. corporations are incorporated under Delaware law, which is considered highly pro-business. Among the benefits Delaware incorporation confers are:
However, a number of state governments, notably Nevada and Maryland, have liberalized their corporation laws to make their states more business friendly, and some may even offer certain benefits Delaware lacks. As a result, medium- to large-sized businesses are choosing to incorporate in other states more frequently than once was common.
Given corporations' unique legal status, perhaps it is no surprise that they are used for diverse business and legal purposes outside the traditional sense of a small (or large) business incorporating itself. New corporations may be created as permanent or temporary holding companies for major corporations, particularly during a major corporate merger or restructuring. Individuals and businesses may also use corporations as tax shelters to channel funds through or as privacy barriers to provide indirect ownership of something, such as real estate or another company.
Alteiri, Mark P. "The IRS's Ability to Attack S Corporation Stock Transfers." Tax Adviser, December 1997.
Diamond, Michael R., and Julie L. Williams. How to Incorporate: A Handbook for Entrepreneurs and Professionals. New York: John Wiley & Sons, 1996.
Epstein, Jonathan D. "Delaware Faces Faster Field in Incorporation Derby." American Banker, 28 May 1997.
Mancuso, Anthony. How to Form a Nonprofit Corporation. 4th ed. Berkeley: Nolo Press, 1998.