Organizational Costs

A corporation is one type of business structure that is created and regulated by state law. More specifically, it is defined as a legal entity that is considered to be separate from its owners, meaning its shareholders. What this means is that only the corporation itself can be held liable for corporate obligations, such as maintaining specific business records.

While there are many different types of corporations, a corporation is generally classified according to specific factors. Some common examples of such factors include, but may not be limited to:

• Their tax structure;
• The purpose of the corporation; and
• The number of shareholders as well as the amount of stock that is to be issued.

Some of the most common forms of corporations include:

• C Corporation;
• S Corporation;
• Non-Profit Corporation;
• Business Corporation;
• Professional Corporation;
• Foreign Corporation; and
• Public or Private Corporation.

However, when someone mentions the term “corporation,” they are generally referring to the two main categories that corporations are divided into according to tax laws: C Corporations and S Corporations. The defining difference between these two types is that C Corporations are taxed separately from their owners, while S Corporations are not.

Some other examples of the benefits to forming a corporation include:

• They can survive changes in ownership, which means that they could theoretically exist forever;
• They are considered to be “people” so they are entitled to specific constitutional protections; and
• Because only the corporation itself can be held responsible for its obligations, they have considerably limited liability.

Corporations are generally created by complying with state corporate laws. The majority of states base their laws on a model act known as the Revised Model Business Corporation Act (“RMBCA”). Additionally, a document known as the articles of incorporation must be filed with the Secretary of State. In order to form the articles of incorporation, the individual owners or shareholders must agree on a number of factors, which include:

• The name of the corporation;
• The number of shares that the organization is authorized to issue;
• The number of shares of stock that each owner will buy, as well as the amount of money that they will contribute to the purchase;
• The specific type of corporation; and
• The people who will form and manage the corporation.

To reiterate, each state maintains its own set of corporate law requirements. As such, there may be additional factors to consider when forming a corporation.

Corporate shareholders generally elect a group of people to serve as the corporation’s board of directors. The shareholders who hold the majority of shares will have ultimate control over the corporation. This is because they have the strongest voting powers, which permits them to elect people to the board of directors.

The board of directors are responsible for making the important corporate decisions, and are required to meet at least once per year. The board then elects the officers of the corporation, who are the ones in charge of making the day-to-day decisions.

What Are Organizational Costs?

When a taxpayer creates a corporation, they will incur a number of associated costs, such as:

• Drafting charters and bylaws;
• Issuing and selling stocks; and
• Registering in the state of incorporation.

It is important to note that only costs that are considered to be “organizational costs” may be amortized over a period no less than 60 months, beginning with the month in which the corporation begins its business. Amortization refers to spreading out payments over a specific amount of time.

To be more specific, organizational costs are defined as expenditures that are:

1. Incident to the creation of a corporation;
2. Chargeable to a capital account; and
3. Of a character that, if expended in order to create a corporation with a limited life, would be amortizable over that limited lifetime.

Some common examples of organizational costs include, but may not be limited to:

• Legal services that are necessary for the creation of the corporation, such as drafting charters, bylaws, and minutes of meetings;
• Necessary accounting services;
• Fees paid for temporary directors and organizational meetings; and
• Registration fees which are paid to the state of incorporation.

What Expenses Are Not Considered To Be Organizational Costs?

Fees that are associated with the issuance and sale of corporate stocks are not considered to be organizational costs. These costs include:

• Printing fees;
• Broker commissions; and
• Related professional fees.

Expenses associated with the transfer of assets to the corporation are also excluded from being organizational costs. Examples of these include:

• Title searches;
• Recording documents; and
• Transportation.

The reason why such costs are excluded from being organizational costs is that these expenses are generally added to the basis of the assets themselves. Additionally, fees for issuing debt are also not treated as an organizational cost. Rather, they may be capitalized and amortized over the life of the debt as interest expense.

What Else Should I Know About Organizational Costs, And Corporations In General?

To reiterate, the corporation must make an election to amortize these expenses over a period of no less than 60 months in its first tax return. Otherwise, these costs must be capitalized, and as such they cannot be deducted until the corporation is dissolved.

Shareholders cannot deduct organizational costs that they incurred themselves. These costs must be added to the basis of the stocks that they receive from the corporation.

In terms of how a corporation is held liable for its debts, to reiterate, a corporation is liable for its obligations. As such, creditors may only rely on the corporation and its business assets in order to receive payments. The individual shareholders are generally shielded from being held personally liable for business losses, as long as the corporation was properly established and is run appropriately. As such, the only risk that the shareholders may face are any investments that they made in the corporation.

One of the disadvantages to forming a corporation is that they are subject to what is known as double taxation. This means that not only must the corporation file its own tax return and pay taxes on its profits, but the shareholders must also pay individual taxes on the dividends that they receive. Additionally, the corporation must report all of the income that it receives and can deduct any business expenses. However, shareholders cannot deduct any corporate losses.

There are some situations in which limited liability will not protect an owner’s personal assets, and for which they can be held personally liable. An example of this would be when an owner:

• Personally and directly causes injury to another person;
• Fails to deposit taxes that are withheld from wages of the corporation’s employees;
• Engages in activity that is intentionally fraudulent or illegal, and that causes harm to the company or someone else;
• Personally secures or guarantees a bank loan and/or a business debt on which the corporation defaults; and/or
• Treats the corporation as an extension of their personal affairs, as opposed to a separate legal entity.

There are some circumstances in which a court can rule that a corporation does not exist, and that its owners are actually doing business as individuals. In these cases, the individual owners may be held personally liable for any business obligations that arise.

Do I Need An Attorney For Issues With Organizational Costs?

If you are experiencing issues associated with organizational costs, you will need to consult with an area tax attorney. An experienced and local lawyer can help you understand your legal obligations and options according to your state’s specific tax laws. Finally, an attorney will also be able to represent you in court, as needed.