Corporations are considered to be separate entities, legally and financially, from their owners, officers and stockholders. In the eyes of the law, a corporation has similar status as an adult who is mentally competent and who has reached majority age, that is, someone considered to be an adult in a specific jurisdiction. This means that the personal assets of the founder of a corporation are not vulnerable to loss due to the activities of the corporation. A corporation may sue and be sued, and may own property.
Because a corporation has separate legal status, the Internal Revenue Service requires a corporation to file a separate federal tax return and pay taxes on its earnings. Stockholders must also include earnings from dividends, which come out of those earnings, on their personal income tax returns. This phenomenon is called "double taxation" because the earnings of a corporation are essentially subject to taxation twice. However the founder, who may also be an officer and a stockholder, is not liable for self-employment tax, that is, the full burden of paying Social Security and Medicare taxes, as she would be if she had formed a sole proprietorship.
Corporations must meet specific requirements before opening for business. Each corporation must register articles of incorporation, or documents that have similar names, with the secretary of state for the state in which it is incorporated. The corporation may incorporate in a different state than the state where the company is physically located. Many corporations choose to incorporate in locations like Delaware or Nevada because their state laws are favorable to businesses. Corporations must also have an Employer ID Number, or EIN, form a board of directors and issue stock.
The IRS recognizes two types of corporations: conventional corporations, also called C corporations, and S corporations. Like C corporations, S corporations have separate legal status, and officers and founders of an S corporation are also exempt from self-employment tax. Unlike C corporations, though, S corporations are not subject to double taxation; their tax returns are generally informational. With an S corporation, earnings pass through directly to shareholders and are, therefor, taxed only once as shareholder income. In return, the IRS places additional limits on S corporations. They are limited as to the number of stockholders they may have and the type of stock they may issue. S corporations must also be domestic, that is, operate entirely within the United States.