A corporation is a separate and distinct legal entity. This means that a corporation can open a bank account, own property and do business, all under its own name. The primary advantage of a corporation is that its owners, known as stockholders or shareholders, are not personally liable for the debts and liabilities of the corporation. For example, if a corporation gets sued and is forced into bankruptcy, the owners will not be required to pay the debt with their own money. If the assets of the corporation are not enough to cover the debts, the creditors cannot go after the stockholders, directors or officers of the corporation to recover any shortfall.
A corporation is managed by a board of directors, which is responsible for making major business decisions and overseeing the general affairs of the corporation. Like representatives in Congress, directors are elected by the stockholders of the corporation. Officers, who run the day-to-day operations of the corporation, are appointed by the directors.
One major disadvantage of a traditional corporation is double taxation. A traditional corporation, known as a "C-corporation," pays a corporate tax on its corporate income (the first tax). Then, when the C-corporation distributes profits to its stockholders, the stockholders pay income tax on those dividends (the second tax).
One way to avoid double taxation is to make a special election to be taxed as a pass-through entity, like a partnership or a sole proprietorship. That way, there is only one level of taxation. The corporate profits "pass through" to the owners, who pay taxes on the profits at their individual tax rates. Corporations that make this tax election are known as "S-corporations."
The life of a corporation begins upon the filing of articles of incorporation with the secretary of state's office. Prior to filing the articles of incorporation, the following issues should be considered.
Where should I form the corporation?
You can incorporate in any of the 50 states.
Many people choose to incorporate in their home state. Doing so may save you money because corporations are required to register as a "foreign corporation" in each state where they do business outside of their state of incorporation, and there is often no need to pay another person to serve as the registered agent. For example, a Delaware corporation that has its main business office in Texas must register as a "foreign corporation" with the Texas Secretary of State and must have a registered agent in Delaware.
However, if your home state has a high corporate income tax or high state fee, and your corporation will not "do business" in the home state, it may be wise to incorporate elsewhere. "Doing business" means more than just selling products or making passive investments in that state. It usually requires occupying an office or otherwise having an active business presence.
Delaware is a popular choice because of its history, experience, recognition and pro-business climate. In fact, over half of the companies listed on the New York Stock Exchange are incorporated in Delaware. Recently, Nevada has also gained popularity due to its pro-business environment and lack of a formal information-sharing agreement with the IRS. Nevada does not have corporate income taxes (and Delaware does not tax out-of-state income), and business filings in these states can usually be performed more quickly than in other states.
Choosing a name
In general, the name of a corporation must end with "incorporated," "corporation," or an abbreviation of one of these. A name will not be accepted if it is likely to mislead the public or if it too closely resembles the name of another corporation formed in that state. Many states also restrict the use of certain terms in a corporation's name (like Bank, Police, or Insurance).
The Litchney Law Firm allows you to choose up to three names, in order of preference. We will conduct a name check before filing to see which names are available. Please note that for government purposes the names "ABC Inc." and "A.B.C. Corp." are identical and you cannot use the word bank without specific approval from the appropriate agencies. Therefore, you should disregard spaces, periods and the corporate ending when coming up with your three different name choices.
If the name of your corporation will be used in connection with goods or services, you may wish to consider obtaining federal trademark protection for the name. This ensures that no one else in the U.S. may use that name in connection with the same general type of goods or services (except in areas where someone else is already using that name).
The Board of Directors
A corporation is managed by its board of directors, which must approve major business decisions. A director can be, but is not required to be, either a shareholder or an officer. Like representatives in Congress, directors are elected by the shareholders and typically serve for a limited term. Each corporation must have at least one director.
Examples of procedures which must be approved by the board of directors include:
- Declaring a dividend
- Electing officers and setting the terms of their employment
- Amending bylaws or the articles of incorporation
- Any corporate merger, reorganization or other significant corporate transaction
Directors of a corporation owe duties of loyalty and care to the corporation. Generally, means that directors must act in good faith, with reasonable care, and in the best interest of the corporation. If a director stands to personally gain from a transaction with the corporation, he or she must disclose this fact and refrain from voting on the matter, if possible.
Officers
Officers are appointed by the board of directors to run the day-to-day operations of the corporation. A corporation must have at least three officers: (1) a president, (2) a treasurer or chief financial officer and (3) a secretary. Officers do not have to be stockholders or directors, but they can be. There is no limit on the maximum number of officers, and no limit on the number of offices that a person may hold. In fact, the same person may hold all offices.
Registered Agent
Each corporation must have a registered agent, the person designated to receive official state correspondence and notice if the corporation is "served" with a lawsuit. The registered agent must be either (1) an adult living in the state of formation with a street address (P.O. boxes are not acceptable) or (2) a corporation with a business office in the state of formation which provides registered agent services.
As previously mentioned, one of the advantages of forming a corporation in your home state is that any officer or director can act as the registered agent. However, there are some advantages to having another person or company act as your registered agent. First, this adds an extra layer of privacy, since the name and address of the registered agent is publicly available. Second, this ensures that if your corporation is named in a lawsuit, no one will surprise you at home on a Sunday night with court papers.
Incorporating is just one step in starting a new business. There are other federal, state, and practical considerations as well. The following is a list of things to do or think about once you have formed a new corporation.
- Consider registering a DBA if you want to do business under a name other than the official corporate name.
- Establish a corporate banking account.
- Contact the state tax board for information about state taxes and obtaining a state tax number.
- Check with the state department of consumer affairs to obtain any required business licenses or permits.
- Contact the Internal Revenue Service for information on filing your federal tax schedules.
- Find out about workers' compensation if you will have employees.
- Protect your trade name – contact our Intellectual Property Attorneys at the Litchney Law Firm for information on federal trademarks and copyright.
- Check zoning laws.
- Obtain city and/or county business licenses or permits.
- Get adequate business insurance or a business rider to a homeowner's policy.
- Get tax information such as record-keeping requirements, guidelines for withholding taxes (if you will have employees), information on hiring independent contractors, facts on estimating taxes, forms of organization, etc.
- Have business cards and stationery printed.
- Get an email address.
- Get your website set up.
The United States Small Business Administration (SBA) offers additional information and resources on starting a new business. You can visit them on the internet at www.sba.gov, or you can contact your local branch office by phone.
If you have decided that the limited liability and the tax structure of a corporation are right for your business, the next step is actually forming the corporation. The law of the state in which you incorporate will dictate exactly what you need to do, but the steps are basically the same. The following outlines what steps you'll need to take to form a corporation.
Articles of Incorporation
The Articles of Incorporation set out the basic information about the corporation. This includes the name of the corporation, the purpose of the business, the number and type of shares authorized, the names of shareholders, the names and addresses of the initial officers and directors, the name of the authorized agent, and the name of the incorporator. The Articles of Incorporation are filed with the State, usually the Secretary of State's office. Check out the forms section of AllLaw.com to see a sample form of Articles of Incorporation.
Bylaws
Bylaws are the document that regulates how the corporation will be run. It covers things such as how often and when shareholders' and board of directors' meetings will be held. It will provide for how much notice should be given prior to a meeting and in what manner notice will be given. This document also sets forth the rules regarding how many shareholders or directors are needed to establish a quorum and how much of a majority vote will be required to take certain actions. For example, the Bylaws may state that a simple majority is all that is necessary to take most actions, but that a two-thirds majority is required to amend the articles of incorporation. The bylaws will also provide for the mechanism by which the bylaws may be changed. For example, bylaws may be changed with the approval of a two-thirds majority of the shareholders. A sample form of Bylaws may be found at AllLaw.com as well.
First Director's Meeting Minutes
The Minutes of the first meeting of the Board of Directors should be prepared in advance. They will cover all of the business that needs to be conducted at that first meeting. The bylaws of the corporation will be adopted. Shares in the corporation will be issued. Authority will be granted to open a bank account and to conduct business in the name of the corporation. Click to see a sample form of First Director's Meeting Minutes.
Those are just the basic steps to forming a corporation. Depending on how you want ownership of your business to be structured, there may be other steps you should take. You may want stock transfer agreements that set out who can own stock in the corporation and how and under what circumstances stock can be sold. You may also want shareholder voting agreements that specify how certain shares of stock will be voted at shareholder meetings. These types of arrangements should be made concurrently with the formation of the corporation. An attorney who practices business law can help you with the preparation of all of these documents.
Corporations enjoy many advantages over partnerships and sole proprietorships. But there are also disadvantages. We cover the most important ones below.
Advantages
Stockholders are not liable for corporate debts. This is the most important attribute of a corporation. In a sole proprietorship and partnership, the owners are personally responsible for the debts of the business. If the assets of the sole proprietorship or partnership cannot satisfy the debt, creditors can go after each owner's personal bank account, house, etc. to make up the difference. On the other hand, if a corporation runs out of funds, its owners are usually not liable.
Please note that under certain circumstances, an individual stockholder may be liable for corporate debts. This is sometimes referred to as "piercing the corporate veil." Some of these circumstances include:
- If a stockholder personally guarantees a debt.
- If personal funds are intermingled with corporate funds.
- If a corporation fails to have director and shareholder meetings.
- If the corporation has minimal capitalization or minimal insurance.
- If the corporation fails to pay state taxes or otherwise violates state law (like defrauding customers).
Self-Employment Tax Savings. Earnings from a sole proprietorship are subject to self-employment taxes, which are currently a combined 15.3% on the first $97,500 of income for tax year 2007. With a corporation, only salaries (and not profits) are subject to such taxes. This can save you thousands of dollars per year.
For example, if a sole proprietorship earns $80,000, a 15.3% tax would have to be paid on the entire $80,000. Assume that a corporation also earns $80,000, but $40,000 of that amount is paid in salary, and $40,000 is deemed as profit. In this case, the self-employment tax would not be paid on the $40,000 profit. This saves you over $5,000 per year. Please note, however, that you should pay yourself a reasonable salary.
Continuous life. The life of a corporation, unlike that of a partnership or sole proprietorship, does not expire upon the death of its stockholders, directors or officers.
Easier to raise money. An corporation has many avenues to raise capital. It can sell shares of stock, and it can create new types of stock, such as preferred stock, with different voting or profit characteristics. Plus, investors be assured that they are not personally liable for corporate debts.
Ease of transfer. Ownership interests in a corporation may be sold to third parties without disturbing the continued operation of the business. The business of a sole proprietorship or partnership, on the other hand, cannot be sold whole; instead, each of its assets, licenses and permits must be individually transferred, and new bank accounts and tax identification numbers are required.
Disadvantages
Higher cost. Corporations cost more to set up and run than a sole proprietorship or partnership. For example, there are the initial formation fees, filing fees and annual state fees. These costs are partially offset by lower insurance costs.
Formal organization and corporate formalities. A corporation can only be created by filing legal documents with the state. In addition, a corporation must adhere to technical formalities. These include holding director and shareholder meetings, recording minutes, having the board of directors approve major business transactions and corporate record-keeping. If these formalities are not kept, the stockholders risk losing their personal liability protection. While keeping corporate formalities is not difficult, it can be time-consuming. On the other hand, a sole proprietorship or partnership can commence and operate without any formal organizing or operating procedures - not even a handwritten agreement.
Unemployment tax. A stockholder-employee of a corporation is required to pay unemployment insurance taxes on his or her salary, whereas a sole proprietor or partner is not. Currently, the federal unemployment tax is 6.2% of the first $7,000 of wages paid, with a maximum of $434 per employee.
If you pay any required state unemployment tax, you can receive an offset credit of 5.4%, effectively lowering the federal rate to 0.8%, for a maximum of $56.00 per employee per year.
For further information or to discuss your business and corporate law issues, we invite you to schedule a free confidential consultation with an experienced northern and southern California business law attorneys by calling us at 916.983.2941, or filling out our contact us form on our website. The confidential consultation is free.
A corporation is a separate and distinct legal entity. This means that a corporation can open a bank account, own property and do business, all under its own name. The primary advantage of a corporation is that its owners, known as stockholders or shareholders, are not personally liable for the debts and liabilities of the corporation. For example, if a corporation gets sued and is forced into bankruptcy, the owners will not be required to pay the debt with their own money. If the assets of the corporation are not enough to cover the debts, the creditors cannot go after the stockholders, directors or officers of the corporation to recover any shortfall.
A corporation is managed by a board of directors, which is responsible for making major business decisions and overseeing the general affairs of the corporation. Like representatives in Congress, directors are elected by the stockholders of the corporation. Officers, who run the day-to-day operations of the corporation, are appointed by the directors.
One major disadvantage of a traditional corporation is double taxation. A traditional corporation, known as a "C-corporation," pays a corporate tax on its corporate income (the first tax). Then, when the C-corporation distributes profits to its stockholders, the stockholders pay income tax on those dividends (the second tax).
One way to avoid double taxation is to make a special election to be taxed as a pass-through entity, like a partnership or a sole proprietorship. That way, there is only one level of taxation. The corporate profits "pass through" to the owners, who pay taxes on the profits at their individual tax rates. Corporations that make this tax election are known as "S-corporations."
The life of a corporation begins upon the filing of articles of incorporation with the secretary of state's office. Prior to filing the articles of incorporation, the following issues should be considered.
Where should I form the corporation?
You can incorporate in any of the 50 states.
Many people choose to incorporate in their home state. Doing so may save you money because corporations are required to register as a "foreign corporation" in each state where they do business outside of their state of incorporation, and there is often no need to pay another person to serve as the registered agent. For example, a Delaware corporation that has its main business office in Texas must register as a "foreign corporation" with the Texas Secretary of State and must have a registered agent in Delaware.
However, if your home state has a high corporate income tax or high state fee, and your corporation will not "do business" in the home state, it may be wise to incorporate elsewhere. "Doing business" means more than just selling products or making passive investments in that state. It usually requires occupying an office or otherwise having an active business presence.
Delaware is a popular choice because of its history, experience, recognition and pro-business climate. In fact, over half of the companies listed on the New York Stock Exchange are incorporated in Delaware. Recently, Nevada has also gained popularity due to its pro-business environment and lack of a formal information-sharing agreement with the IRS. Nevada does not have corporate income taxes (and Delaware does not tax out-of-state income), and business filings in these states can usually be performed more quickly than in other states.
Choosing a name
In general, the name of a corporation must end with "incorporated," "corporation," or an abbreviation of one of these. A name will not be accepted if it is likely to mislead the public or if it too closely resembles the name of another corporation formed in that state. Many states also restrict the use of certain terms in a corporation's name (like Bank, Police, or Insurance).
The Litchney Law Firm allows you to choose up to three names, in order of preference. We will conduct a name check before filing to see which names are available. Please note that for government purposes the names "ABC Inc." and "A.B.C. Corp." are identical and you cannot use the word bank without specific approval from the appropriate agencies. Therefore, you should disregard spaces, periods and the corporate ending when coming up with your three different name choices.
If the name of your corporation will be used in connection with goods or services, you may wish to consider obtaining federal trademark protection for the name. This ensures that no one else in the U.S. may use that name in connection with the same general type of goods or services (except in areas where someone else is already using that name).
The Board of Directors
A corporation is managed by its board of directors, which must approve major business decisions. A director can be, but is not required to be, either a shareholder or an officer. Like representatives in Congress, directors are elected by the shareholders and typically serve for a limited term. Each corporation must have at least one director.
Examples of procedures which must be approved by the board of directors include:
- Declaring a dividend
- Electing officers and setting the terms of their employment
- Amending bylaws or the articles of incorporation
- Any corporate merger, reorganization or other significant corporate transaction
Directors of a corporation owe duties of loyalty and care to the corporation. Generally, means that directors must act in good faith, with reasonable care, and in the best interest of the corporation. If a director stands to personally gain from a transaction with the corporation, he or she must disclose this fact and refrain from voting on the matter, if possible.
Officers
Officers are appointed by the board of directors to run the day-to-day operations of the corporation. A corporation must have at least three officers: (1) a president, (2) a treasurer or chief financial officer and (3) a secretary. Officers do not have to be stockholders or directors, but they can be. There is no limit on the maximum number of officers, and no limit on the number of offices that a person may hold. In fact, the same person may hold all offices.
Registered Agent
Each corporation must have a registered agent, the person designated to receive official state correspondence and notice if the corporation is "served" with a lawsuit. The registered agent must be either (1) an adult living in the state of formation with a street address (P.O. boxes are not acceptable) or (2) a corporation with a business office in the state of formation which provides registered agent services.
As previously mentioned, one of the advantages of forming a corporation in your home state is that any officer or director can act as the registered agent. However, there are some advantages to having another person or company act as your registered agent. First, this adds an extra layer of privacy, since the name and address of the registered agent is publicly available. Second, this ensures that if your corporation is named in a lawsuit, no one will surprise you at home on a Sunday night with court papers.
Incorporating is just one step in starting a new business. There are other federal, state, and practical considerations as well. The following is a list of things to do or think about once you have formed a new corporation.
- Consider registering a DBA if you want to do business under a name other than the official corporate name.
- Establish a corporate banking account.
- Contact the state tax board for information about state taxes and obtaining a state tax number.
- Check with the state department of consumer affairs to obtain any required business licenses or permits.
- Contact the Internal Revenue Service for information on filing your federal tax schedules.
- Find out about workers' compensation if you will have employees.
- Protect your trade name – contact our Intellectual Property Attorneys at the Litchney Law Firm for information on federal trademarks and copyright.
- Check zoning laws.
- Obtain city and/or county business licenses or permits.
- Get adequate business insurance or a business rider to a homeowner's policy.
- Get tax information such as record-keeping requirements, guidelines for withholding taxes (if you will have employees), information on hiring independent contractors, facts on estimating taxes, forms of organization, etc.
- Have business cards and stationery printed.
- Get an email address.
- Get your website set up.
The United States Small Business Administration (SBA) offers additional information and resources on starting a new business. You can visit them on the internet at www.sba.gov, or you can contact your local branch office by phone.
If you have decided that the limited liability and the tax structure of a corporation are right for your business, the next step is actually forming the corporation. The law of the state in which you incorporate will dictate exactly what you need to do, but the steps are basically the same. The following outlines what steps you'll need to take to form a corporation.
Articles of Incorporation
The Articles of Incorporation set out the basic information about the corporation. This includes the name of the corporation, the purpose of the business, the number and type of shares authorized, the names of shareholders, the names and addresses of the initial officers and directors, the name of the authorized agent, and the name of the incorporator. The Articles of Incorporation are filed with the State, usually the Secretary of State's office. Check out the forms section of AllLaw.com to see a sample form of Articles of Incorporation.
Bylaws
Bylaws are the document that regulates how the corporation will be run. It covers things such as how often and when shareholders' and board of directors' meetings will be held. It will provide for how much notice should be given prior to a meeting and in what manner notice will be given. This document also sets forth the rules regarding how many shareholders or directors are needed to establish a quorum and how much of a majority vote will be required to take certain actions. For example, the Bylaws may state that a simple majority is all that is necessary to take most actions, but that a two-thirds majority is required to amend the articles of incorporation. The bylaws will also provide for the mechanism by which the bylaws may be changed. For example, bylaws may be changed with the approval of a two-thirds majority of the shareholders. A sample form of Bylaws may be found at AllLaw.com as well.
First Director's Meeting Minutes
The Minutes of the first meeting of the Board of Directors should be prepared in advance. They will cover all of the business that needs to be conducted at that first meeting. The bylaws of the corporation will be adopted. Shares in the corporation will be issued. Authority will be granted to open a bank account and to conduct business in the name of the corporation. Click to see a sample form of First Director's Meeting Minutes.
Those are just the basic steps to forming a corporation. Depending on how you want ownership of your business to be structured, there may be other steps you should take. You may want stock transfer agreements that set out who can own stock in the corporation and how and under what circumstances stock can be sold. You may also want shareholder voting agreements that specify how certain shares of stock will be voted at shareholder meetings. These types of arrangements should be made concurrently with the formation of the corporation. An attorney who practices business law can help you with the preparation of all of these documents.
Corporations enjoy many advantages over partnerships and sole proprietorships. But there are also disadvantages. We cover the most important ones below.
Advantages
Stockholders are not liable for corporate debts. This is the most important attribute of a corporation. In a sole proprietorship and partnership, the owners are personally responsible for the debts of the business. If the assets of the sole proprietorship or partnership cannot satisfy the debt, creditors can go after each owner's personal bank account, house, etc. to make up the difference. On the other hand, if a corporation runs out of funds, its owners are usually not liable.
Please note that under certain circumstances, an individual stockholder may be liable for corporate debts. This is sometimes referred to as "piercing the corporate veil." Some of these circumstances include:
- If a stockholder personally guarantees a debt.
- If personal funds are intermingled with corporate funds.
- If a corporation fails to have director and shareholder meetings.
- If the corporation has minimal capitalization or minimal insurance.
- If the corporation fails to pay state taxes or otherwise violates state law (like defrauding customers).
Self-Employment Tax Savings. Earnings from a sole proprietorship are subject to self-employment taxes, which are currently a combined 15.3% on the first $97,500 of income for tax year 2007. With a corporation, only salaries (and not profits) are subject to such taxes. This can save you thousands of dollars per year.
For example, if a sole proprietorship earns $80,000, a 15.3% tax would have to be paid on the entire $80,000. Assume that a corporation also earns $80,000, but $40,000 of that amount is paid in salary, and $40,000 is deemed as profit. In this case, the self-employment tax would not be paid on the $40,000 profit. This saves you over $5,000 per year. Please note, however, that you should pay yourself a reasonable salary.
Continuous life. The life of a corporation, unlike that of a partnership or sole proprietorship, does not expire upon the death of its stockholders, directors or officers.
Easier to raise money. An corporation has many avenues to raise capital. It can sell shares of stock, and it can create new types of stock, such as preferred stock, with different voting or profit characteristics. Plus, investors be assured that they are not personally liable for corporate debts.
Ease of transfer. Ownership interests in a corporation may be sold to third parties without disturbing the continued operation of the business. The business of a sole proprietorship or partnership, on the other hand, cannot be sold whole; instead, each of its assets, licenses and permits must be individually transferred, and new bank accounts and tax identification numbers are required.
Disadvantages
Higher cost. Corporations cost more to set up and run than a sole proprietorship or partnership. For example, there are the initial formation fees, filing fees and annual state fees. These costs are partially offset by lower insurance costs.
Formal organization and corporate formalities. A corporation can only be created by filing legal documents with the state. In addition, a corporation must adhere to technical formalities. These include holding director and shareholder meetings, recording minutes, having the board of directors approve major business transactions and corporate record-keeping. If these formalities are not kept, the stockholders risk losing their personal liability protection. While keeping corporate formalities is not difficult, it can be time-consuming. On the other hand, a sole proprietorship or partnership can commence and operate without any formal organizing or operating procedures - not even a handwritten agreement.
Unemployment tax. A stockholder-employee of a corporation is required to pay unemployment insurance taxes on his or her salary, whereas a sole proprietor or partner is not. Currently, the federal unemployment tax is 6.2% of the first $7,000 of wages paid, with a maximum of $434 per employee.
If you pay any required state unemployment tax, you can receive an offset credit of 5.4%, effectively lowering the federal rate to 0.8%, for a maximum of $56.00 per employee per year.
For further information or to discuss your business and corporate law issues, we invite you to schedule a free confidential consultation with an experienced northern and southern California business law attorneys by calling us at 916.983.2941, or filling out our contact us form on our website. The confidential consultation is free.