Are you looking to start a business in America and find a business entity that will grow with you?
Because corporations are a popular business option in America, many entrepreneurs form them.
What exactly is a corporation? And why is it so common?
This entity type gives entrepreneurs a formal business structure that allows them to expand their company. We’ll explain everything you need to know about how to form a corporation in your state.
What is a Corporation?
Corporations are a special entity type. They allow a group to run a business together while the entity enjoys corporate personhood which grants the corporation many of the same rights and privileges as a person.
A corporation is considered an individual by law. Individuals have the right to buy assets, sue or get sued, hire employees, and many other rights. Corporations also have these rights.
Corporations have the unique ability to issue stock. Shares are not allowed to be issued by any other type of entity. Shareholders own these stocks. In essence, they hold a portion of the net worth of the company. Therefore, shareholders are the true owners of the corporation.
However, just because a person owns shares doesn’t make them a manager in the company. Voting shareholders can elect directors to the corporation. The board of directors, in turn, governs the corporation through the appointment of officers. These officers oversee the day-to-day operations of the company.
A corporation gives you a few legal protections. The corporation is legally separate from its members and is therefore an individual entity.
This distinction means that members are not liable for corporation debts unless the business was operated in an improper manner or if the owners have acted fraudulently. The corporation will not be affected by the bankruptcy of a member.
What are the Steps to Form A Corporation?
It takes a lot of planning and time to form a corporation. You will also need to pay some registration fees. Before you rush to start the process, make sure you are certain that the corporation is right for you.
A corporation has the advantage over other entities in that it can raise money by issuing stock. It is important to realize that stockholders have the ability to vote and play a part in running the business. This means you are giving up some of your decision-making power. An LLC, or another type of entity, may be better if you wish to keep full control.
These steps will help you form your company once you have chosen a corporation.
1 Choose a Name
The first step towards your success is to create the perfect name for your business. It is just as important as the business idea itself. Names must be unique and comply with legal requirements.
No matter where you are incorporated, your business name can’t be identical to a name claimed by another entity. It also cannot be similar to names that are already in use. Some words, such as “bank” and “insurance”, are restricted to only those businesses that operate in these industries.
After you have chosen a name, your business can be either incorporated immediately or retained for future purposes. While you are preparing to set up your business, you can reserve your name for a limited time. In addition to that, registering a domain name for your business is a huge step in creating a brand.
2) Designate a registered agent
A registered agent should be appointed by corporations. This is an important role to ensure that the state has a reliable point for contact with your corporation. Your Articles of Incorporation must include the address and name of your registered agent. To keep your personal obligations low, you can also hire a registered agent service.
3) Fill out your Articles of Incorporation
Your corporation will not be officially created until you have filed your incorporation documents with the Secretary of State. The articles of incorporation are the required document in most states.
Although the information in this document may vary from one state to another, there are some elements that all states require. To receive important legal documents for your business, you will first need to select a registered agent. On the form, you will be asked for the address and name of your agent.
Next, you will need to appoint directors for your first board. Most states require at least one to three initial directors. However, you may appoint additional directors if necessary.
4) Create your Corporate Bylaws
The bylaws of a corporation are the most important documents your company will have. These bylaws are required by law and outline corporate policies. This document will contain information about your company, such as its purpose statement, officers, financial year schedule, meeting schedules and the process of adding or subtracting members to the board, dissolution process, and so on.
5) Get an EIN
Next, you will need to obtain a federal tax ID number from the Internal Revenue Service. The EIN, which is nine digits in length, is used to identify your company for tax purposes. It is similar to a Social Security Number for individuals. EINs can be used to help your company accomplish important tasks such as opening bank accounts and hiring employees.
6) Have an initial meeting with your Board of Directors
Your first meeting with your new board will set the tone for future business ventures. The first meeting of your new board of directors will discuss the key aspects of your business such as your bylaws, setting up shareholder and stock agreements, and appointing managers to run your daily business affairs.
7) Register for Taxes
Taxes are an essential part of running a compliant company. You’ll need to register both for federal and state taxes. Most corporations will have to pay federal income taxes and state corporate income taxes. Wyoming and South Dakota, however, are the only states that do not have this type of tax.
Additional taxes such as those relating to employment or specific industries may be required. If you have questions about taxation, you might want to speak with an accountant or tax professional.
8) Obtain Business Licenses
To be able to function properly, most businesses will require at least one license. Businesses involved in agriculture, for example, must obtain a license through the U.S. Department of Agriculture. Licenses are also required for many other industries. Some states also require a general business license to be able to operate any business. For more information about licensing, the Small Business Administration has a resource you can consult.
9) Open a Business Bank account
It is not a good idea for your business expenses or personal finances to be tied down with someone else’s. This could lead to the demise of your corporation and even cause you and your owners to lose personal asset protection. You will need a business bank account to avoid the interplay between your personal and corporate finances. This is also a good time to start your accounting system. It is possible to use accounting software such as QuickBooks. However, if your company has complex financials it may be better to hire an accountant.
Tenth – Maintaining Your Corporation
After you have completed the formation process, your business is ready to go. You need to be aware of a few other important points that will help you keep your business legal and running smoothly.
First, you have to pay your taxes each year. Because corporate taxes can be complex, it may be a smart idea to hire an accountant. Most states require that you file an annual report on your business. This gives the state a snapshot of your company’s activities over the past year. It is vital that all corporations keep detailed records of their business activities. This includes meeting minutes, financial reports, as well as financial reports.
Pros and Cons of a Corporation
There are pros and cons to running a corporation, just like any other business. Some businesses find the rigidities of operating a corporation to be more detrimental than beneficial. It’s also not surprising that corporations require extensive maintenance.
We’ll be covering the six main advantages and five drawbacks of forming a corporation. What entity type is best for your company?
The Pros and Cons of Creating a Corporation
1. Creating a corporation offers significant benefits. One of the greatest advantages is the fact that you are not personally liable for the corporation’s actions.
Your personal assets are protected by what is commonly known as the “corporate veil”. Your personal assets, such as your bank accounts, home, and investments, cannot be used as collateral if the corporation is in debt or has to go to court. The corporate veil is only effective when the corporation follows all legal requirements.
2. A corporation can also issue stock to raise funds. Stock can only be sold by corporations. Stock can be issued by both private and public corporations. However, public corporations are more likely to issue stock. Corporations can sell stock or share to raise funds for new campaigns and projects that wouldn’t otherwise be possible.
3. Corporations may also be allowed to deduct certain benefits that they offer their officers and employees. This tax deduction is not available to all entities.
4. A corporation’s lifespan is virtually limitless. The entity will continue to exist until it is either intentionally dissolution by its owners or when the date of dissolution has passed. In rare cases, corporations may plan ahead to dissolve at a specific date.
5 In the same way, the transfer of stock ownership is very simple. Other entity types, such as sole proprietorships or LLCs, require a lot more paperwork and filing fees to change owners.
6. Lastly, smaller corporations can file for S-corp status. This allows them to receive significant tax reductions. This business entity is subject to a “pass-through” taxation system, meaning that taxes are paid only at the individual level and no corporate income tax.
Cons of Creating a Corporation
There are some disadvantages to being a corporate owner, despite its many benefits. These should be considered.
1. One, corporations can be expensive to create and maintain. In Washington D.C. for example, the annual report is $300 and the incorporation cost is $220. Although not all states are as expensive, almost all require an annual report each year. There are also other fees. These fees can quickly add up.
2. Second, the government heavily regulates corporations. There are many regulations for corporations, both federal and state. Many states have a whole chapter in their statutes that is dedicated solely to corporations. These requirements must be met if you want to protect your personal assets.
This could result in you losing some of the creative freedom and autonomy you had as a different entity.
3. Nobody enjoys paying taxes. Unfortunately, the tax burden of a corporation is greater than that of most other entity types. The corporation’s personal tax liability is lower than the individual one. This is because you will only pay taxes on income received as an employee or dividends earned by the corporation. However, the corporation pays a lot.
Double taxation is imposed on C corporations. This can make the burden even more severe. Double taxation means that the corporation must pay corporate income tax at 21% on its profits. When the corporation passes on its profits to shareholders as dividends, they also pay tax on the income. S-corporation status is the only way to avoid this taxation. This is only available to smaller companies.
4. A corporation may not be the best choice if you are looking to have complete control over the management of your company. A corporation is usually managed by several officers and not one owner. In some cases, however, the management team may be unaccountable to the owners.
If a corporation has many shareholders, but not a clear majority, it would be impossible for them to direct the actions of its board. These situations are not common, but they do happen.
5 A corporation takes a lot of work and is expensive. It can take a lot of time to file the paperwork. You will need to file annual reports, maintain business licenses, keep detailed corporate records, host meetings for your board and shareholders, and many other tasks.
You have two options: either hire someone to keep your records and file paperwork on your behalf (e.g., a registered agent) or you can do it yourself. You’ll need to spend some time maintaining these files.
The most important decision you will make regarding your business is what entity type you should form. However, it can be difficult to choose the right entity type.
This decision can be made easier if you know the pros and cons. Corporations are a very popular type of entity. They provide entrepreneurs with a structured business structure that is ready to grow with their company.
A corporation is more costly and takes longer to manage than a limited liability company. However, the LLC is not nearly as attractive to investors as a corporation and is less well-equipped for growth.
However, an LLC may have a lower tax burden than a corporation. You can choose which type of entity best suits your business’s unique needs.
Corporation VS Other Entities
We’ve discussed the advantages and disadvantages that the corporation has over other business entities throughout this article. We have detailed articles on each topic that will help you understand how the corporation compares with a general partnership, sole proprietorship or LLC.
Let’s now look at the differences and similarities between each type of business to help you decide if a corporation is right for your company.
- Corporation vs. Sole Proprietorship/General Partnership: A sole proprietorship or general partnership is basically the same thing. Both are informal business entities and don’t need to be formed. The only difference between them is that the sole proprietorship is for one person, while the general partnership is for at least two. These business types don’t provide personal asset protection. This is why we wouldn’t recommend operating a general partnership or sole proprietorship instead of a corporation.
- Corporation or LLC? Here’s where things get more complicated. There are some clear advantages to the LLC over the corporation. They have flexible taxation, flexible business structures, a simpler formation process, and (usually) lower maintenance expenses. The corporation does have some advantages. It can issue stock and attract venture capitalists. Although there are many exceptions, the LLC is the preferred entity type for most small businesses. The corporation is a good choice for larger businesses with ambitious expansion plans.
Things to ask yourself before you form a corporation
Corporations may not be right for everyone. Here are some questions to ask yourself if you are unsure if you should form a corporation or another legal entity.
They will help you decide if a corporation is right.
1. What level of confidence do you have about your business idea?
Although it is impossible to predict how the market will react to a new company, your gut may tell you that your idea is right for your region. It’s a good idea to be confident about your business plan.
You will need to spend both time and money in order to create a corporation.
However, sole proprietorships and general partnership owners face liability risks. If you feel confident in your business model, it is a good idea to incorporate your company.
2. What level of risk are you taking?
Your risky behavior may impact the type of entity you create. Here’s why: Someone has to pay if something goes wrong in your business.
Let’s take, for example, a skydiving company. Safety is your top priority. But, one day, a defective parachute harness causes one client to fracture their ribs while diving. Who pays the damages if the diver who has broken his ribs sues?
Personal asset protection is the key to this scenario. If you are a sole proprietorship, general partnership, or limited liability company, you will need to pay the settlement yourself. Your assets would be taken if your business could not make the payment. However, a corporation has personal asset protection through the corporate veil. The corporation would pay the settlement and not any individual members.
Companies that are at high risk for potential damage face higher settlements. These businesses should consider forming corporations.
3. What level of control do you desire over your business?
The type of entity you choose will affect the level of autonomy you have over your business affairs. For example, sole proprietorships are managed exclusively by their owner. Although there are some regulations that govern informal business structures, these are not as extensive as those required for corporations.
There are many regulations that corporations must follow at the federal and state levels. The original incorporator is rarely the one who controls a corporation. If the stock is also eligible for voting rights, the control will pass to the shareholders.
A single-member LLC may be better if you need to have complete control of your business.
4. What are your plans to grow your business?
You will need a way to quickly raise capital if you have ambitious plans to grow your company. Corporations have the unique ability to sell stock. This allows businesses to quickly raise capital. Others would need to wait for capital to grow through the natural flow or apply for loans.
You should also consider the number of people that you would like to add to your business. Are you looking to bring in other owners or members to increase your expertise or are you just looking to hire employees? How easy it is for you to add members to the business depends on what type of entity you have.
To add members to an LLC, for example, you will need to file additional paperwork. A sole proprietorship would also have to change its entity type to allow the addition of a new owner. However, corporations have much more flexibility in changing the owners of their business. A simple stock exchange can do this.
If you plan to make the shares of your corporation public, you will need to form a corporation. Corporations are the only entity that have this privilege, as we’ve mentioned.
5. Do you accept the downsides of starting a corporation?
Before you make a decision on a corporation to form, it is important that you are both fully aware and comfortable with the potential negatives. Three main drawbacks should be considered.
This is due to the corporation’s obligation of maintaining extensive corporate records and complying with legal requirements. There are many rules to be followed, as we mentioned earlier. It is difficult to even read all of them and to implement them.
Corporations are subject to higher taxes than other types of business. Corporation income taxes can get quite high. Some states also charge a corporate income tax as well as a gross receipts fee. C-corporations are also subject to double taxation. The corporation’s income and dividends are taxed.
The last problem with a corporation is how much time it takes for one to be formed and maintained. While good record-keeping habits can help offset this problem, you still have to submit annual reports and pay quarterly taxes. You can either hire someone to handle the paperwork or you could choose another entity type.
These drawbacks may not bother you, but a corporation could be right for you.
Hire an incorporation service
Do you find this tedious? Do you prefer to have someone else incorporate your company, so you can focus on growing your business? There are many reputable incorporation companies that offer professional assistance at a fraction of the cost of a lawyer.
It can be hard to choose the right company when there are so many companies offering incorporation services. We have compiled a comprehensive guide to the best-rated online business formation services. All of our readers are encouraged to review that guide and find the best company for their specific circumstances. We’ll also briefly mention a few of our favorites options.
What is the best time to incorporate your business?
The next question to ask is when your business should be incorporated. The incorporation process can be complicated and can take a lot of time. We recommend that you form your corporation before you begin doing business with your company.
Why? It all boils down to the protection of personal assets afforded by corporations. To “ease into” ownership of your business, you’ll be personally liable for any transaction that you make. This is because these informal business entities don’t offer any limited liability protections.
The corporate veil protects everything you do as a business, so long as you properly form and maintain it. This protection is essential for any type of business, so it’s important to incorporate yours when you are certain about your business model.
The True Cost of Incorporating A Business
Entrepreneurs often ask us how much it costs to incorporate.
Other than the filing fee, there are additional costs associated with incorporation. You should be aware that each state has its own incorporation rates. The additional costs may vary from one state to the next (and even industry to industry in some cases).
Let’s look at some other costs. A name reservation fee is not usually required. It is required in Alabama, but it is optional elsewhere. A name reservation fee is minimal in most states. In many cases, it will cost between $10-20.
You can also add costs by using an incorporation service. Most companies charge additional fees to incorporate. Your new company’s bottom line will be affected by whether or not you choose to use a registered agent service. Your expenses will increase if you choose to have an attorney assist you.
There’s also the issue of annual and initial reports. Although initial reports are not required in all states, they are an important part of the formation process for those states that require them. Annual reports are required by most states from corporations. The costs vary from $10 in Colorado to $300 in Maryland.
Corporations also have to consider taxes. There are different corporate tax rates in each state. Some also have additional fees like franchise taxes. Your business’s cost of operation will vary depending on whether it is a C-corporation or an S corporation.