What Medical Spa Owners Need to Know About Corporations

Posted By Mike Meyer, Wednesday, March 11, 2020

corporation formation

By James M. Stanford, JD, Partner, ByrdAdatto

The corporation is one of the oldest types of business model, and it is likely the most common entity type that comes to mind when you think of a business. The concept of a corporation was first developed under Roman law, and it was adopted by England in the early 17th century as a distinct legal entity.

Corporations became commonplace in the United States at the turn of the 19th century, during the Industrial Revolution. Investors and owners increasingly were drawn to the corporation as an efficient means by which to operate a large enterprise while offering liability protection to the shareholders. Today, the corporation is a mainstay for domestic and international business.

Limited Liability

One of the main advantages of forming a corporation is that the owners and their personal assets are protected from creditors of the corporation; this is known as the "corporate veil." Except in rare situations, the owners typically stand to lose only the money invested in the corporation. Accordingly, only the corporation's assets need be used to pay business debts and obligations.

There are certain circumstances under which an owner of a corporation can be held personally liable for the obligations of the corporation. The owner, for example, may be personally liable if they failed to withhold or otherwise remit taxes withheld from employees' wages, or treated the corporation as an extension of their personal affairs, rather than as a separate legal entity. In such circumstances, the third party would be allowed to "pierce the corporate veil" and hold the shareholders personally liable for the corporation's acts. Although "piercing the corporate veil" is not commonplace, an owner should never commingle personal assets with business assets.

Formation and Governance

Similar to other entities, filing a certificate of formation or articles of incorporation with the state government, typically the secretary of state's office, is required to form a corporation. Depending on the size and complexity of the corporation, however, this filing may be much more complex than with other entities, such as a limited liability company or limited partnership.

Governance of a corporation is typically established through a combination of the certificate of formation, bylaws and possibly a shareholders' agreement. The bylaws establish the basic rules that govern the ongoing formalities and decisions of corporate life. This usually includes the requirements for regular and special meetings of directors and shareholders, the quorum needed for such meetings, the number of votes that are required to approve corporate decisions, and other governing decisions. A shareholders' agreement may supplement the bylaws regarding how the corporation should be operated and provide special shareholders' rights and obligations. The agreement may include information on the management of the corporation and the privileges and protection of shareholders, or special rights for certain classes of shareholders. For example, these rights could include voting provisions for the election of directors, restrictions and rights of first refusal on shares transfers, preemptive rights, and tag-along and drag-along rights.

Corporate Income Tax

The notion of possible "double taxation" is one of the primary drawbacks of a corporation. Unlike a partnership and other pass-through tax structures, such as the "S corporation," the corporation itself must pay tax on income before profits are distributed to the owners.

Historically, tax rates were much higher, ranging from 15% to 35%, but this recently changed to 21% under the Tax Cuts and Jobs Act. While the shareholders can elect for a corporation to be taxed under Subchapter S of the Internal Revenue Code—an S-corporation—there are substantial restrictions on ownership and share structure, typically reserving the S-corporation designation for small businesses only.

Types of Corporations

While the distinction between an S-corporation and C-corporation is merely tax election and not a state-level structural difference, there are a few other types of corporations. General business corporations are usually reserved for larger enterprises. Close corporations, however, often are used for smaller enterprises in which all or most of the shareholders are actively involved in the management of the business. Most states typically allow close corporations more flexibility in management. Professional corporations are another type, but these are limited to licensed professionals, as their name would suggest, and only professionals licensed in the corporation's field may be shareholders.

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James M. Stanford is an attorney and partner at the ByrdAdatto law firm. From transitions, mergers, and acquisitions to structuring complex ownership arrangements, James enjoys the personal reward that comes from bringing parties together and making deals happen. James practices primarily in the areas of health care and corporate law with a focus on intellectual property. A proud father, Jim served in the U.S. Army and is fluent in Russian. In his spare time, he enjoys hunting, fishing, and spending time outdoors.

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