Updated November 23, 2020:

The requirements for small business corporations are crucial for you to understand if you are planning on forming one. Understanding the caveats of forming a corporation versus forming other entity types will allow you to make the best decision.

Small Corporation Business Definition

There are several definitions of a small business.

  • According to the IRS Subchapter S election guideline, a small business must have less than 100 shares to make a subchapter S election.
  • A Small Business Corporation is also defined as a corporation which raises money from investors and have a paid-in surplus totaling no more than $1,0000,000  and meets all other guidelines outlined in the Internal Revenue Code (26 USCS § 1244 (c)). This code allows shareholders to claim ordinary losses on valueless stock. 
  • According to USCS § 1361, a small business corporation is a domestic corporation who is not owned by another corporation or a non-US citizen and only has one class of stock.

What Exactly Is a Corporation?

The difference between other business entities and a corporation is that a corporation legally stands on its own. Thus, a corporation is a separate entity from its owners. In other words, a corporation is its own "person" and therefore can do the following:

  • Create contracts
  • Acquire debt
  • File taxes
  • Exist after the original owners die

Moreover, business owners who form a corporation have limited liability protection within a corporation. 

What Is Limited Liability and Why Is it Important?

Limited liability means that a corporate shareholder does not risk being personally liable for the corporation's debt. It is important because in most cases, an owner cannot be personally held liable his company's debts and liabilities. Suppose a corporation is sued for a debt and the creditor wins the suit. The creditor can only go after the corporation's assets.

Keep in mind that the corporation must adhere to certain guidelines to maintain shareholder protection. Furthermore, owners must show that the corporation indeed works as its own entity.

Are Corporations Different from Partnerships, Sole Proprietorships, or LLCs?

Corporations are different because they offer a protection you can't get from a partnership and sole proprietorship.  A corporation offers a special kind of protection. The corporate status shields your personal assets from corporate liabilities and debt.

The only other entity that offers this type of protection is a limited liability company (LLC). LLCs also offer their owners limited personal liability protection. While it requires paperwork to form, it is easier to maintain your LLC status compared to a corporation. For instance, LLC owners are not subject to strict corporate mandates like holding regular shareholder meetings.

Still, the biggest difference between corporations and other business entities is how they are taxed. Since a corporation is treated as a "person," it is subject to taxes. Corporations pay taxes on profits less all expenses including salaries, bonuses, overhead and other expenses. LLCs, partnerships, and sole proprietorships, on the other hand, are not taxed. Instead, the taxes pass through to the owners. Hence, the owners file their portion of profits or losses on their own tax returns.

Who Would Benefit from Forming a Corporation?

You should not form a corporation for the limited liability benefits since you get those same benefits if you form an LLC. However, you may benefit from forming a corporation in the following situations:

  • You want to attract and retain highly skilled employees by offering them stock options.
  • Your business is highly profitable, and you want to save on taxes. 
  • You are running a family business and want to gift shares without losing ownership or control of your business.
  • You have an opportunity to have strategic partnerships or high-revenue generating clients, but they require you to have a corporate status.

How to Form a Small Business Corporation

  • File your articles of incorporation with your states Secretary of State's office or the governing body that handles entity formation in your state. 
  • Make sure to include your business's legal address as well as the information for your corporation's registered agent.
  • Create your corporate by-laws which govern how you run your business and meet with your shareholders to issue stock before you open for business.

If you need help forming a corporation, post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.