Everything You Should Know About Setting Up a Corporation
When you think of corporations, most people immediately think of a large business with an international presence. Most of these businesses are indeed corporations, but almost anybody can start a corporation if they follow the correct steps. Corporations are the most complex business structure possible, but also offer protections that other business structures do not.
Read on to learn about this process and determine if a corporation is a right fit for your business.
What is a corporation?
Corporations are a business structure that allows the owners to create a separate legal entity from themselves. A concept known as “corporate personhood” allows these businesses to operate as their own entity, including entering into contracts, loan agreements, and legal proceedings. The owners and shareholders of the corporation are not held liable for corporate debts and obligations. In other words, business owners aren’t obligated to use their personal assets to cover business debts.
As part of forming a corporation, a defined two-level structure is assigned within the business. The first level is made up of owners, who are typically shareholders. The second level is the active management level, including corporate officers and a board of directors. Shareholders can be officers, but do not have to be.
Different types of corporations
Corporations can be formed in a number of ways, with the type of corporation influencing the structure and tax status of each business. Below is a list of different corporate structures. You’ll notice a limited liability company is not on the list, as LLCs are not corporations.
A C corporation is the most basic form of a corporation. These businesses can have unlimited shareholders and are able to become public and even be listed on the stock exchange, allowing members of the public to purchase shares of the company and become partial owners. This ability to sell shares of ownership is often enticing to companies who will seek significant investments from multiple sources.
C corporations do not have to exist publicly, though they can. They can also issue stock privately to stockholders, allowing owners to maintain more control over the pool of shareholders.
One defining feature of a C corporation is its tax status. These companies file and pay corporate income tax returns in addition to shareholders paying federal income taxes through their dividends.
Once a C corporation has been established, entrepreneurs can choose to convert to an S corporation. This is technically not a business structure but is instead a type of elected tax status. S corporations elect to pass their corporate income, losses, deductions, and credits to their shareholders for the purpose of federal taxes. Shareholders will still pay individual income taxes related to dividends, but no corporate tax will be levied.
There are some limitations on S corps, such as a cap of 100 shareholders who must all be citizens of the United States.
Aside from C and S corps, there are other less common forms that can be used in certain scenarios.
- A B corporation is a for-profit business that is structured to benefit society and meets the standards of the B Impact Assessment. These businesses operate as a C or S corporation but receive a public assessment to demonstrate a commitment to social good.
- Closed corporations are privately held companies owned by only a few shareholders, with shares not publicly traded.
- Non-profit businesses are a form of corporation, however, they cannot distribute profits to members, directors, or officers. These companies have tax advantages in exchange for heavy restrictions on how money can be spent.
Who should form a corporation?
Most small businesses with one or two owners will not choose to form a corporation. However, in some cases, this will be the best structure. Corporations offer the strongest protection from personal liability, which is the main driver for most people choosing this. Industries that are more prone to litigation and risk may choose a corporation for that reason.
A corporation is also a good choice if you want to have a public company that sells shares, or any other distinction between shareholders and officers.
The record-keeping and reporting requirements for a corporation are much more strict than other structures, so a corporation is only the right choice if you are able to keep up with these regulations. This includes tax requirements and the additional work of double-taxation.
Advantages of starting a corporation
Personal liability protections
No other type of business entity offers as much liability protection as a corporation. If a corporation is sued or owes large amounts of money, the shareholders will never be personally responsible for those debts and legal outcomes. These businesses can go entirely bankrupt without a financial impact on the shareholders.
Perpetuity of business
In sole proprietorships and partnerships, the death of an owner can mean the automatic dissolution of the company. Corporations offer much more flexibility to transfer ownership and maintain the business securely. Because stock ownership is split between multiple shareholders, there is ownership maintained in the event of a departure or death. The bylaws and articles of corporation for each individual business will lay out the exact steps to be taken in these scenarios.
Access to capital
Corporations are able to easily raise funds by selling stock, especially when the stock is publicly traded. Other entities do not have the ability to get funding this quickly, both in the early stages as well as later in a business’ lifespan.
While some corporations, like C corps, are subject to double taxes, others may not. S corps allows for income to be split between the business and shareholders, meaning it is taxed at different rates, or to entirely pass through the income to be reported on only personal income taxes.
Disadvantages of starting a corporation
Formal process to incorporate
Unlike other structures, the application process to start a corporation can take a long time. Extensive paperwork is required to document the details of the organization and its ownership, likely with the help of lawyers and multiple rounds of edits.
Maintaining a corporation is also more complex than other business structures. A corporation needs to adhere to its own bylaws and articles of incorporation, as well as follow state corporate laws to maintain its board of directors, hold annual meetings, and create annual reports. States may also have restrictions on what corporations can and cannot do.
Most corporations will face double taxation, where the business itself is taxed as an entity and the shareholder is taxed based on their personal profits. S corporations are able to avoid this, but can only be formed in certain scenarios, and they may be watched more closely by the IRS.
Forming and maintaining a corporation can be a costly endeavor. Startup costs can be high, and the formality of incorporating can include fees like filing charges. Ongoing fees will usually be necessary, as well as a larger tax bill.
Steps to setting up a corporation
Name your corporation
Each state has a set of rules surrounding what a corporation can and cannot be named. These usually include that the business name must be unique when it comes to other businesses in the state and must include a corporate designator, like “Corporation” or “Incorporated” at the end. Most states don’t require you to register a name at this stage, though you can usually pay a small fee to reserve it until you are ready.
If you will be using a name other than the one stated in your articles of incorporation, you may also need to file for a fictitious or trade name with your state.
All corporations must have directors who make major policy and financial decisions on behalf of the company. Directors may authorize the issuance of stock, appoint corporate officers, decide officer salaries, and approve loans for the corporation. Initial owners usually appoint these directors- they may appoint themselves but are not always.
Most states require only one director for each corporation, regardless of the number of shareholders. Some states require the number of owners to be the minimum number of directors.
File Articles of Incorporation
In order to register your corporation with the state, you will need to prepare and file articles of incorporation. This is typically done through your state department, and some states may have a different name like “charter” or “certificate of incorporation”.
Corporations do not require more than one owner, but any owners must sign the articles of incorporation or appoint someone to do so. These articles can be very complex if you choose, but they can also be very simple and most states offer a form. The main components will be the name and principal address, as well as the name of the directors. There is usually some filing fee associated with this.
Create corporate bylaws
Bylaws are internal rules regarding the day-to-day operations of a corporation, like when meetings will occur and what voting requirements are needed to reach a decision. There are many templates you can use to create these, or a lawyer can help you draft them. At the first board meeting, the bylaws will be adopted.
Hold a meeting of the board of directors
At this point, the board of directors must hold an initial meeting to take care of some formalities and make decisions. They may discuss the corporation’s fiscal calendar, appoint officers, adopt the bylaws, and authorize the issuance of stocks. It is also important that minutes are taken at this meeting to be included in annual reports.
Before a corporation can do any business, it should issue shares of stock to formally divide up the ownership interests. This must be done to qualify for the legal protections offered by a corporate status. There are a large number of laws surrounding how stocks can be issued and when, so it is always helpful to consult an attorney during this process.
Obtain licenses, permits, and zoning clearances
The federal government, states, and localities each have laws pertaining to licensure for operating a business. The federal laws are around certain industries, while state and local governments often require general business licenses, as well as permits in order to collect and remit sales tax. It is important to look into all of your local licensing guidelines to ensure you are able to operate as planned in each location.
Maintain annual requirements
In addition to filing taxes in a timely manner, corporations also have other official and legal documents they must produce. The most common is an annual report, which covers the yearly finances and minutes from board meetings. Public corporations will also need to supply information to the Securities and Exchange Commission, which is more extensive than filing requirements for a private company.
What resources are available to provide further assistance?
Most of what you will need to start a corporation will be specific to your state, with information available through the state department. Below are some resources that you can use to navigate this process.
- The IRS provides information on how to form a corporation and handle it when filing income taxes.
- The U.S. Small Business Association has information on how to register with federal and state entities.
- This website has a directory of all Secretary of State offices and websites for easy access.
Can one person form a corporation?
Yes, a corporation only requires one shareholder for formation, and they can also be a director. However, that sole shareholder will still need to comply with all regulations that a larger corporation would, including the tax obligations for their profits and all annual reporting.
Can I start my business as an S corp?
The first step in forming an S corporation is to formally create a C corporation. From there, the directors can elect to change their tax status to an S corporation, and then file for this with the state. All of the same filing and requirements for a C corporation will apply, but the taxation process will be different once this has happened.
Do corporations require a registered agent?
When filing to incorporate your business, you will need to supply a registered agent’s information. This person acts as a representative of the company and can receive mail in their name. The registered agent can be the owner of a corporation, a director, or anyone else who has a legal address.
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