However, with respect to taxes, the C corporation itself is considered a taxable entity. That means that it files a tax return and pays income taxes on its net income. If the corporation then distributes income in the form of dividends to the shareholders, they are taxed again on the income.

This is often referred to as the double tax of corporations. Most small businesses can avoid or reduce this double tax by paying substantial compensation and providing benefits to the shareholders who work in the business.

Compensation and benefits are generally tax deductible to the corporation as a business expense. If a benefits plan is structured properly, the value of the benefits may not be considered taxable income to the employee.

Compensation must be reasonable or there is the possibility that the IRS could reclassify it as a dividend making it subject to the double tax problem. The other method of avoiding or reducing the double tax is to elect an S corporation status. Unlike a C corporation, an S corporation itself is not a taxable entity.

The S corporation files an informational tax return on form 1120S, but the corporation itself does not pay taxes on the net income of the business. An S corporation is a pass -through entity which means the profits or losses are reported by the owners (shareholders) on their individual tax returns.

An S corporation can also pay compensation to shareholders who work in the business. If the S corporation distributes income to the shareholders, there is no double tax because the S corporation as an entity does not pay any tax. Only the shareholders of the S corporation report and pay income taxes on their prorata share of the business net income.

The most basic and simple form is the sole proprietorship, which involves business ownership by one person or in some cases by husband and wife. Other forms include a partnership, limited partnership, regular or C corporation, S corporation, Limited Liability Company (LLC) or Limited Liability Partnership (LLP).

Corporations have sometimes been called legal fictions, meaning they exist only because the state law authorizes their existence. Corporations were first authorized by state laws to provide a form of doing business where a person could invest money in a business venture without subjecting their personal assets or property to liability.

Corporations are considered legal entities, separate and apart from the shareholders or people who own them. Thus, if a corporation is sued and the court rules against the corporation, the law allows the judgment holder to satisfy the judgment (get paid) only from the assets or property of the corporation and not the private property of the individual shareholders.

This corporate attribute is called limited liability protection. In a sole proprietorship or partnership, a judgment can be satisfied from the personal property of the individual owners of the business if there are insufficient business assets to satisfy the judgment.

Not only do corporations owe their existence to state law, but they are also governed and regulated by the corporate laws of the state in which they are incorporated and/or in which they choose to do business.

Note: If a corporation sells stock, it may also be regulated by state and federal security laws.

The corporation laws for many states can now be found online. If you need to review the corporate law in your state, the following sources may help.

For more information on state laws visit:
http://www.findlaw.com/11stategov/or/laws.html