The Business Advisor THINGS YOU NEED TO KNOW ABOUT YOUR CORPORATION AND CORPORATE STOCK by Mary Hanson

Most active operating businesses are corporations.  Most business owners have been stockholders in a corporation owned solely by them or in a corporation owned with other shareholders. 

Nevertheless, the level of understanding of corporations is not always what it should be. 

This is intended to be a painless list of some of the things you need to know about your corporation (and your corporate stock):

• Stock is personal property, just like a car, a coin collection, or a television set.  It can be freely transferred unless there are restrictions placed on it as part of the way the stock was issued or by a shareholder agreement.  

• Your stock represents all liabilities of the corporation and all assets of the corporation. You are not liable for the liabilities of the corporation (unless you have guaranteed them or you have done something else which makes you legally responsible). 

• You are not entitled to the assets of the corporation.  All of these belong to the corporation.  Only the stock, representing your ownership in the corporation, belongs to you.

• If you take money or other assets out of your corporation, it must be compensation, a dividend, a distribution of S corporation profits, repayment of debt, or redemption of stock.  The tax consequences of each one are very different.

• A “redemption” of stock is when the corporation buys some or all of your stock from you. 

• If you are the only shareholder in your corporation, then the number of shares you hold is the “total outstanding.”  You own 100%.   If you held 2,000 shares and the corporation bought back (redeemed) 1,000 shares, you still own 100% of the corporation, because only “issued and outstanding” shares are counted.

• If you own stock in a corporation with other shareholders, your ownership percentage is the number of shares you hold divided by the total “issued and outstanding” (held by all shareholders).  Redeemed stock doesn’t count.  Authorized stock doesn’t count. 

• You cannot force someone to buy your stock.  You cannot abandon stock and say that you no longer own it.  To “get rid” of stock you must find someone to buy it or else liquidate or dissolve the corporation.  You can give stock as a gift, although tax law makes this a tricky area from a tax standpoint.  Do not make gifts of stock without working with your tax advisor. 

• If you die, someone will inherit your corporate stock, including whatever business assets (and liabilities) are in the corporation.

• The “protection” from a corporation (or other entity) comes from the separation between you and the corporation.   If you do not respect the separate status of the corporation, you may be personally held liable as if the corporation did not exist.

• In order to maintain the separate status of the corporation, you must keep the corporate assets separate from your assets and you must comply with legal requirements.  Your corporation must be complete (stock issued for initial capital, directors elected, meetings held, actions approved, etc.).

• California law requires yearly meetings of the shareholders.  The reason for holding annual meetings of the shareholders is to comply with legal requirements and respect the separateness of the corporation.

• The reason of an annual meeting of the Board of Directors for a California corporation is that your bylaws probably require it, and that most corporate actions and approvals are actions of the Board of Directors.

• Corporations always must have three roles filled: shareholders, officers, and directors.  These are distinct roles.

• You probably wear all three “hats” of your corporation:  shareholder, director, and officer.  You must know when you are acting as each one.  Any contract signed by the corporation is signed by an officer.  It should not be signed by you personally.  It should not be signed by you as a director or a shareholder.

• Shareholders have little power in the corporation. All the shareholders can do is vote on really major corporate issues and vote to elect directors.  Even though the shareholders elect the directors (and have the power to vote to remove the board) they do not control the board of directors.

• A shareholder is not entitled to a job at a corporation.  A shareholder-employee can be fired. 

• The Board of Directors is the real power of the corporation, even though the directors may never be seen by employees, vendors, or anyone else.  The names of directors never show up.  You do not sign anything as a director.  But if your bank wants proof of which officers can sign on your corporate bank account, a resolution of the Board of Directors is required, which is signed by the Secretary of the corporation.

• Corporate rules for your corporation are set by the state in which your business is incorporated.  The rules referred to here are from California law.  

• The required officers are the President, the Secretary, and the Treasurer.  The officers of the corporation serve “at the pleasure of the board.”  Officers are just employees (high level employees) who can be fired, promoted, demoted, etc. 

• If you are the only shareholder in your California corporation, you should be the sole director and should probably be the only officer.  You do not need other people as directors or officers in a California corporation that has only one shareholder.

• If you have a California corporation with two shareholders you must have at least two directors.  If you have three or more shareholders you must have three or more directors. 

• When your corporation bylaws were adopted you set the number of directors for your corporation.  If you want to change the number of directors for your corporation, amend your bylaws by following the provision in your bylaws regarding amendments.

• Having a Nevada (or other non-California) corporation does not protect you from California taxes if you have a location in California and you do business here.  You will have to qualifyto do business in California and will be subject to California taxes.

• Don’t put appreciating or depreciating assets into a corporation.  Corporations do not have preferential capital gains rates and often cannot use a capital loss.  Such assets, including collectibles, real estate, and investment funds create problems when you want to sell the asset or transfer the asset. 

• Since 2003, “qualified dividends” are taxed at 15%.  If your corporation has accumulated or current earnings and profits, talk to your accountant about taking the profits as dividends.

• If you have an S corporation, your best way to take money out of your corporation is probably as distributions of S corporation profits. 

• If you have loaned your corporation money, repayment of that debt is tax-free money to you.  Repayment of debt may be your best way to take money out of your corporation.

• If you want to change from a regular corporation to an S corporation, have your accountant calculate the tax consequences of such a conversion before you make your decision.  The change can create a heavy tax burden on some businesses. 

• S corporation shareholders (except owners of less than 2% of the shares) cannot get tax-deductible employee fringe benefits. If you want to have a corporation that provides you the maximum tax-optimized benefits of health insurance, life insurance, medical reimbursement plan, and other benefits, you may not want to be an S corporation.

Copyright 2004  Mary Hanson. All rights reserved.