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S Corporation Taxes

PAGE 2
Incorporation

Corporations are considered separate, legal and taxable entities from the owners of the corporation. Most corporations are C corporations, taxable under Subchapter C of the IRS Code (Don't confuse C corporations with Schedule C to the 1040 mentioned above. They're entirely separate and unrelated beasts). Just as you file a 1040 personal income tax return and pay taxes on your earnings, so too, a C corporation files Form 1120 and pays taxes on its earnings.

But remember, a corporation is a separate entity from yourself, even if you own 100 percent of the corporation. So money within the corporation isn't really your money. It's the corporation's money. And the corporation might not think too highly of your spending $100 of its money on a small gift for your spouse or significant other. Unfortunately, the corporation, like the scarecrow in The Wizard Of Oz, has no brain. It can't protect itself from your pilfering.

So to handle this, when formed, the shareholders of a corporation adopt articles of incorporation or bylaws to administer the decision-making for the corporation. And the corporation selects people to oversee its affairs. The shareholders elect a board of directors, who in turn, usually select a CEO to manage the company on a day-to-day basis. The articles of incorporation also determine such things as the date of the corporation's annual meeting and any limitations on the transferability of shares of stock in the corporation.

So, what's your relationship to your corporation?

First, you're almost certainly a shareholder. This means you ultimately own a piece of any profits the corporation earns. (That's not to say that you can pull the profits out willy-nilly as you please!) Plus, you have some say in the selection of the board of directors. The details for voting for board-of-director members within the corporation is determined by the bylaws. For a small corporation, you're also probably on the board of directors, and, you might well elect yourself CEO, among other roles.

As the president of the corporation and as someone who provides services for the corporation, you're an employee of the corporation. You can begin to see that you have a complex, formal relationship with the corporation you've formed. If you violate the formality, as I discuss in my book, Thinking Like An Entrepreneur, you risk having the government disallow the liability protection of your corporate structure. If you have other investors in your corporation, you could get into really deep doo doo by violating the rules of your relationship with the corporation. The quickest way to violate your formal relationship with your corporation is to transfer funds in arbitrary fashion between yourself and your corporation. Incidentally, when you formed your corporation, you probably contributed some money to the company (capital) and in exchange you received a fixed number of corporate shares, giving you a certain percentage ownership of the company.

So where's your money? continued

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