A corporation is a separate legal entity from its owners, owned by one or more shareholders. The corporation must be established in compliance with the statutory requirements of the state of incorporation. The shareholders elect a board of directors which has responsibility for management and control of the corporation. Because the corporation is a separate legal entity, the corporation is responsible for the debts and obligations of the business. In most cases, shareholders are insulated from claims against the corporation.
It is worth noting here that because a corporation is an entity separate from its owners, if the owner (and/or members of the owner’s family) performs services for the corporation, these persons are considered to be employees of the corporation. Thus, the corporation will be required to comply with most of the laws and regulations and reporting requirements applicable to employers. The corporation may be taxed under Subchapter C of the Internal Revenue Code (a “C corporation”) or be subject to the provisions of Subchapter S of the Code (an “S corporation”). Minnesota tax laws provide for comparable treatment.
A C corporation reports its income and expenses on a corporation income tax return and is taxed on its profits at corporation income tax rates. The Minnesota corporate franchise tax, sometimes called an income tax, is based on the income of a C corporation’s income allocated to Minnesota. Profits are taxed before dividends are paid. The dividends are taxable income to the shareholders. Sometimes this is incorrectly referred to as “double taxation”, when instead it is two separate legal entities being taxed on their separate income.
An S corporation election may be made by the shareholders of the corporation if the corporation meets the statutory requirements for S corporation status. The S corporation is taxed in much the same manner as a partnership, i.e., the S corporation files an information return to report its income and expenses, but it generally is not separately taxed. Income and expenses of the S corporation “flow through” to the shareholders in proportion to their shareholdings, and profits are allocated and taxed to the shareholders at their individual tax rate. Under the Internal Revenue Code, an S corporation may have only one class of stock, no more than 100 shareholders, and no shareholders that are nonresident aliens or non-individuals (e.g., corporations, partnerships, limited liability companies) except for certain estates, trusts, and certain tax exempt entities. The federal 2004 American Jobs Creation act allows an S corporation to treat shareholders within six generations of one family as one shareholder thus allowing family business S corporations to distribute shares to family members of existing shareholders without those new shareholders being counted as new shareholders against the 100 shareholder limit.
A closely held corporation is any corporation whose shares are held by a relatively small number of shareholders. The Minnesota Business Corporation Act defines a closely held corporation as one which does not have more than 35 shareholders. Most closely held corporations are relatively small business enterprises, in which all shareholders tend to be active in the management of the business. Some states provide a separate, less formal, less restrictive set of laws for closely-held corporations. Minnesota does not. In Minnesota, the business corporation law is geared to small corporations, so a separate law is not necessary, and all corporations operate under one law.