By Shannon John
For me, the old adage, “If it looks like a duck, and quack likes a duck, then it must be a duck!” brings to mind the importance of running your corporation like a real corporation. I have seen too many business owners fall into the trap of running their companies the same way they did before they were incorporated. Incorporating has its benefits, but in order to receive the privileges, you must meet the obligations!
Although your company may be run like a corporation to you, is it a real corporation under the guidelines of the law? You may not already know this, but in order to be treated like a corporation, your corporation must look and act like one. If you don’t treat it like a corporation, no one else will.
You might be thinking, “But I am a one man show! How can I act like a corporation if I’m the only person working in my business?” This is a good question! The difficult part of a one-person corporation is that you must remember at all times which function you are serving in. To give you a quick breakdown of how you will represent the many hats you wear from day to day, here’s a brief guide to follow.
Roles in a corporation: (examples)
- You can be a stockholder, a director, an officer and an employee of the same corporation.
- When choosing yourself as director for the corporation, you are acting as a stockholder.
- When drafting corporate resolutions, you’re acting as a secretary.
- When signing contracts or other documents, you’re acting as an officer.
- When sweeping the floor you are acting in the capacity of an employee.
In one-person corporations such as this, corporate formalities become the crucial element of proof that you are in fact doing business as a corporation, rather than as a sole proprietor. “Corporate formalities” is a term which encompasses certain functions within the operation of a corporation which prove that a corporation is acting properly. Corporate formalities include annual meetings of stockholders and directors, minutes of meetings, Board of Directors resolutions (which document the directors’ thinking), and proper appointment of officers. Small, one-person corporations have the greatest difficulty with corporate formalities. They experience difficulty, not because corporate formalities are difficult, but rather because many business people forget to observe them. The best way to avoid problems is simply to keep up with your corporate records, hold your annual meetings, and stop and think which role you are playing at any given time. Entrepreneurs who do so seldom find this to be difficult or onerous.
More on Corporate Formalities
Now let’s talk about the most important thing regarding the operation of your corporation. What are corporate formalities? They are, simply stated, the responsibilities of keeping your corporate records in compliance with all laws and regulations.
You’ve probably heard about lawyers “piercing the corporate veil”—going around the corporation to hold the owners personally liable for its debts. This is tragic, especially since it’s so easy to prevent.
You may naively assume that because you’ve incorporated and followed the standard protocol to form your entity that you’ve taken of everything and now you can sit back, relax, and reap the rewards. Wrong! Like that old saying about the duck—if you want the liability and asset protection of a corporation, you must run your company (no matter how big or how small) like a real corporation.
How do you make sure a corporation looks and acts like a corporation? Well, the first thing is to make sure all of your letterheads, stationery, business cards, statements, etc.—anything you write or say about your business—should say “Inc.,” “Corp,” “Co.,” or “LLC.” Then your business looks like a corporation and you are presenting it to the public as being a corporation.
Furthermore, when you set up a corporation, you should give it a reasonable amount of money to carry out its purpose. You can do that by buying stock in your corporation.
The corporation’s thinking is done by the Board of Directors. Therefore, when the corporation has a thought, those thoughts must be reduced to written form and contained in the corporate records as proof that it was, in fact, the corporation that thought and acted. Each time a corporation makes any major decision, it should be noted in the corporate record book in the form of minutes or resolutions.
When this is done, the corporate entity is preserved and safe!
In fact, the fewer stockholders a corporation has, the more important this becomes. Certainly in the case of a one-person corporation, it is literally all important!
You will often hear stories of outsiders “penetrating the corporate veil.” That is why it is all important to observe corporate formalities. Courts look at the corporate records to determine if the corporation acted as a corporation or as an individual. If it acted as a corporation, all decisions are documented as proof that it was the corporation acting, not the individual. Therefore, if the corporation documents its acts by minutes or resolutions, then the individual is insulated from the acts of the corporation.
The bottom line is—to be treated and recognized as a corporation you must observe the corporate formalities which are as follows:
- Required Meeting: Annual meetings are not always required of the stockholders and directors, but these meetings help to document the actions of the corporation as well as provide proof of the ongoing pursuit of the purpose for the corporation to exist. Therefore, they should be properly recorded in the corporation record book.
- Minutes of Meetings: When a meeting is held for any purpose, it is important to observe the corporate formalities and document said meeting in the corporate record book.
- Resolutions: Aside from the required annual meetings, the easiest way to govern and observe corporate formalities in a small, private corporation is by resolutions signed by a quorum of its directors or stockholders (as applicable). Put many resolutions in your corporate record book concerning everything you do, and you will be protecting both the corporation and the individual stockholders.
- Articles/Bylaws: The Corporation must comply with the rules and regulations set forth by the corporation in these documents. Study them closely, comply with them, and again, you will be observing corporate formalities. Nothing about a corporation is irrevocable. If you as a majority do not like either of those documents at any time, or you think they should be changed, it’s very
- Comingling business and personal funds: The corporation must have its own checking account for business purposes only. Do not pay personal expenses out of the corporate checking account. For instance, do not write a corporate check for groceries. Do not write a corporate check for cash, without an explanation as to where the cash went. Keep your accounts clean. Also, for tax reasons, it is vital to put adequate explanations on the corporate checks you write and to have receipts or cash tickets to back them up. For example, in the case of a company car, the corporation pays all the expenses, and the checks must be made out so this is readily ascertainable. You, as an individual, may be reimbursed by the corporation for cash tickets for gasoline, oil changes and so on. So, when the corporation writes you a check for those items, the check should be identified as “Reimbursement for cash tickets attached”, and they should be listed. This procedure keeps personal and business monies separate and helps to keep your accounts clean and your records straight.
- Proper signatures: When you sign anything on behalf of the corporation, such as invoices, delivery receipts, contracts or other items of indebtedness, always sign everything “XYZ Corporation, by John Doe, President” (or Secretary, or Treasurer, or whatever your capacity is). This gives public notice you are signing as an officer of the corporation and not as an individual. This is one of the formalities that prevents piercing of the corporate veil. If you sign as an individual, anyone can say they thought that’s what you obviously intended, because that is what you wrote. By signing as an individual, you are standing alone.
Ultimately, please know that in order for your company to be treated like a corporation, your corporation must look and act like one. You can easily attain this type of asset and liability protection through maintaining sound corporate records on a consistent basis.
Remember to keep all of your business records including receipts, financial documents, major purchase agreements, documentation of hiring and firing employees, and any other records related to the tax deductions you plan to take, in a safe place preferably in a binder where you can prevent exposure to wear and tear from happening.
Also, word to wise—back up your documents on your computer or flash drive. And, for triple protection, take a picture of your records and receipts! This way you are fully protected from a natural disaster, losing documents in a home or office move, or an honest human error.
Start implementing these important tips today and you’ll be well on your way to preventing yourself from experiencing a devastating audit or lawsuit. Don’t learn something like this the hard way. Protect yourself, plan ahead, and be prepared before the storms hits.