Operating Formalities
Corporate Formalities are formal actions that must be performed by a Corporation's director, officers, or shareholders in order to maintain the protection afforded by the formation of the Corporation. These are essential procedures that serve to protect the personal assets of a Corporation's directors, officers, and shareholders. The Primary Formalities are:
- Corporate Funds must be maintained separate and apart from Personal Funds.
The corporate entity should have it's own banking accounts (to include checking, lines of credit, etc.). Not keeping these funds separate, also known as "co-mingling," can lead to increased scrutiny and potentially serious liability in the event of audit by the IRS and the endangerment of personal assets. It is a best practices procedure not to co-mingle funds.
- Meetings of the Board of Directors' must be held at least annually, usually following closely behind Shareholder meetings (also known as "Special Meetings"). All 50 states mandate a meeting being held at least once a year.
These annual meetings should be used to approve transactions entered into by the Corporation.
In lieu of attendance by any given Director, written consent must be provided by said Director (either in the form of a waiver in the absence of proper notice, or in the form of a proxy vote given proper notice) for any decisions made at these meetings.
Meetings of the Shareholders, also known as "Special Meetings" can be held at any time.
The Corporation's Secretary is responsible for giving proper legal notice of these meetings, and for maintaining the necessary waivers, proxies, minutes, etc.
- Corporate Minutes, or "notes of the meetings of the Board of Director's or Special Meetings" are essential and are the official, legal record of such meetings.
The Corporate Minutes are to be maintained in date order in the Corporate Minute Book, and can be a valuable asset in the protection of the Corporation's directors', officers' and shareholders' assets. Proper, timely maintenance of these minutes is essential in defending against audits by IRS and alter ego claims.
Directors and Corporate Officers will at times seek legal counsel during annual meetings, and any discussions during these sessions are considered privileged conversations and protected by the legal doctrine of Attorney-Client Privilege. However, minutes taken of these conversations are considered part of the Corporate record and hence care must be taken, by the Corporate Secretary, to note when these communications occur by citing them in the Corporate Minutes as "Conversations by the members of the board of directors and legal counsel engaged in legally-privileged conversation at this point" instead of noting the actual conversation verbatim.
- Written Agreements for all transactions should be executed and maintained.
All transactions that involve real estate leases, loans (whether internal or external), employment agreements, benefit plans, etc. that are entered into by or on behalf of the Corporation must be in written agreement form.
Improper or untimely documentation of internal loans from a Shareholder to the Corporation, for example, may lead to IRS re-classification of repayment of the principal on said loan as a dividend, with the commensurate tax liabilities incurred by the Shareholder
It is imperative that executive compensation, capital asset acquisitions, etc. be timely and properly documented in these minutes. Failure t properly and timely documents these can potentially lead to tax liabilities on the part of the Directors, Officers, or Shareholders as a result of IRS "reclassification." For example, the IRS may classify what they deem as "excessive, undocumented executive compensation" as a dividend by the corporation to the recipient, and hence not tax deductible by the corporation--this will lead to increased, unpaid tax liabilities.
We cannot stress highly enough that failure to observe and implement these formalities will serve to diminish and mitigate the protections offered by the formation of the Corporation and will allow outside entities (the IRS, creditors, claimants/plaintiffs, potential adverse litigants, etc.) to "pierce the corporate veil" and peer into the inner workings and assets of the Corporation, it's Officers, Directors and Shareholders.
