Are you starting a business in America, and you’re looking for a business entity that can grow with your company?
Many entrepreneurs choose to form corporations, as this business type has long been one of the most popular options for American companies. But what exactly is a corporation, and why is it such a common entity type?
This entity type provides entrepreneurs with a formal business structure that can easily grow with your company as you expand your operations. Below we'll outline everything you should understand about forming a Corporation and how to incorporate in your state.
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Getting Started: Select your state below to incorporate a business on your own. Alternatively, you can hire an online incorporation service to take care of the paperwork for you.
What Is a Corporation?
A corporation is a unique entity type because it allows a group of people to operate a business together, while the entity itself enjoys corporate personhood, which gives the corporation itself many of the same rights as a person.
In the eyes of the law, a corporation is an individual. Individuals are able to purchase assets, sue or be sued, hire employees, and more — corporations have those rights as well.
A unique feature of corporations is their ability to issue stock. No other entity type may issue shares. These stocks are owned by shareholders — essentially, a shareholder owns a percentage of the company’s net worth, and in a sense, shareholders are the owners of the corporation.
Simply owning shares does not make an individual a “manager” in the business, however. Instead, voting shareholders can elect the corporation’s directors. In turn, the board of directors governs the corporation by appointing officers, and those officers manage the day-to-day activities of the business.
Forming a corporation grants a few important legal protections. Most importantly, the corporation is an individual entity and is legally separate from the members which comprise it.
Due to this distinction, members cannot be held liable for the corporation’s debts, unless the business is maintained improperly, or if the owners acted in a fraudulent manner. Similarly, the corporation will remain unaffected by a member who goes bankrupt.
What Are the Steps to Form a Corporation?
Forming a corporation requires a considerable amount of time and planning, and you’ll also need to pay a few registration fees. Before you jump into the process, you should be sure that the corporation is the right entity for you.
The primary advantage of a corporation compared to other entity types is the potential to raise funds by issuing stock. However, it’s important to understand that since stockholders can play a role in leading the business by voting, you’re essentially giving up a portion of your decision-making to someone else. If you want to retain full authority, an LLC or another entity type may be a better choice.
Once you’ve decided on a corporation, you’ll need to follow these six steps to form your business.
1) Choose a Name & Reserve It
Creating the perfect moniker for your business is the first step to your success. It’s nearly as important as your business concept itself. You’ll need to create a name that is both unique and compliant with legal requirements.
No matter which state you incorporate in, your business name cannot be the same as a name that’s been claimed by another entity, and it also cannot be too similar to any names already in use. There are also some restricted words like “bank” or “insurance” that are only available to businesses operating in those industries.
Once you’ve picked a name, you can either incorporate your business immediately, or reserve the name for future use. Reserving your name will protect your name for a fixed period of time while you prepare to get your business set up. For more information on business names and reserving a name, you can find a guide to your state here.
2) File Your Articles of Incorporation
Your corporation is not officially formed until you file your incorporation documents with the Secretary of State. In most states, the necessary document is called the articles of incorporation.
The information included in this document varies from state to state, but there several elements that are required by all states. First, you’ll need to choose a registered agent to receive important legal documents on behalf of your business. You’ll be asked to list the name and address of your agent on the form.
Next, you must appoint directors to serve on your initial board. Most states require you to have at least one to three initial directors, but you can appoint more if you wish.
3) Hold an Initial Meeting with Your Board of Directors
The first meeting of your new board of directors will set the tone for all future business endeavors. You’ll need to discuss key features of your business, such as bylaws, setting up your stock and shareholder agreements, and appointing officers to manage the daily business affairs.
4) Register for Taxes
Taxes are a vital part of operating a compliant business, and you’ll need to register for taxes on both the state and federal levels. For example, most corporations will need to pay federal and state corporate income taxes — Wyoming and South Dakota are the only states without that type of tax.
Other taxes, such as employment taxes or industry-specific taxes, may also be required. Taxation can be complicated, so you may want to consult with a tax professional or an accountant if you have any questions.
5) Obtain Business Licenses
Most businesses will need to acquire at least one license to operate properly. For example, businesses involved in agriculture need to obtain a license from the U.S. Department of Agriculture, and many other industries also require licenses. The Small Business Administration offers a helpful resource that you can consult for more information on licensing.
6) Get a Business Bank Account
The last thing you want is for your business expenses to get tied up with someone’s personal finances. That would defeat the purpose of forming a corporation, and could even see your owners lose their personal asset protection. To avoid the intersection of personal finances and your corporation’s, you’ll want to get a business bank account.
7) Maintaining Your Corporation
Once you’ve completed the formation process, you’re ready to operate your business. There are a few more important issues to address that can help keep your business running smoothly and legally.
First, you must pay your taxes every year, and since corporate taxes can be complicated, it might be a good idea to enlist the help of an accountant. In addition to taxes, most states also require you to file an annual report for your business, which gives the state a snapshot of your corporation’s activities for the year. Finally, it’s vital that every corporation keeps detailed records of all its business activities, including meeting minutes, your business ledger, financial reports, and more.
Pros and Cons of a Corporation
Like any business, there are pros and cons to operating a corporation. For some businesses, the rigid formalities of the corporation are more of a negative than a positive, and it’s no secret that corporations can require some extensive maintenance.
In this guide, we’ll cover the six key advantages and six disadvantages to forming a corporation. Is it the right entity type for your company?
Pros to Forming a Corporation
Forming a corporation has significant advantages. Perhaps the most important advantage is the limited personal liability that accompanies a corporation.
Thanks to what’s commonly called the “corporate veil,” your personal assets are protected. If the corporation runs into debt or legal trouble, your own personal bank accounts, house, car, and investments cannot be taken as collateral. (Note: the corporate veil only functions as protection when the corporation follows the proper formalities as dictated by law).
Another advantage is that a corporation can issue stock in order to raise funds. Only corporations can sell stock. Both private and public corporations can issue stock, but public corporations gain the most by issuing stock. By selling stock or shares, corporations can gain funds for new projects and campaigns that would be unattainable otherwise.
Corporations can also deduct the cost of certain benefits it provides to its employees and officers. This deduction provides a tax cut that not all entity types can take advantage of.
In addition, the lifespan of a corporation is practically limitless. The entity will endure until it is intentionally dissolved by the owners, or the date of dissolution has been reached. (In rare instances, a corporation plans in advance to dissolve on a certain date). Similarly, transferring the ownership of a corporation through the transfer of stock is fairly simple.
For other entity types such as LLCs and sole proprietorships, changing owners requires a lot of paperwork and filing fees.
Finally, smaller corporations have the option to file for S corporation status, which grants significant tax cuts. This business entity has a “pass-through” form of taxation, which means taxes are only paid at the individual level, and there is no corporate income tax paid.
Cons to Forming a Corporation
Despite its benefits, there are disadvantages to a corporation that you should consider.
For one, corporations are relatively expensive both to form and maintain. For example, in Washington D.C., the cost to incorporate is $220, and an annual report costs $300. Not all states are so expensive, but almost all require an annual report each year, and other yearly fees exist as well. These costs can add up quickly.
Secondly, corporations are heavily regulated by the government. Regulations for corporations abound, as both the federal government and state governments have numerous rules. Most states have an entire chapter of their statutes dedicated to corporations alone. To maintain your personal asset protection, you must comply with these requirements.
As a result, you could lose some of your creative freedom and autonomy that you might have as a different entity type.
No one enjoys paying taxes, and unfortunately, the tax burden for a corporation is higher than most entity types. Technically, the personal tax liability is lower in a corporation, as you personally will pay taxes only on the income you receive as an employee, or from dividends you receive from the corporation. The corporation itself, however, pays a lot of taxes.
A C corporation is subject to what’s known as double taxation, so the burden can be especially high. With double taxation, the corporation pays corporate income tax on its own profits at a rate of 21%. Then, when it passes the remaining profits on to its shareholders in the form of dividends, the shareholders also pay taxes on their income from those dividends. The only way to bypass this heavy taxation is with S corporation status, which is exclusively available to smaller corporations.
If you want full control of the management of your business, then a corporation might not be the right choice for you. Usually, a corporation is led and managed by multiple officers, not just one owner, and in some cases, the management team can be left unaccountable to the actual owners of the corporation.
For example, if a corporation has a large number of shareholders but there is no clear majority, they would not be able to dictate the actions of the board. While these situations are rare, they can occur.
On top of being expensive, a corporation requires a lot of time. Simply filing the initial paperwork can require a significant time investment. Then later, you’ll need to file annual reports, maintain your business licenses, keep meticulous corporate records, hold meetings for your board of directors and your shareholders, and more.
You can hire someone to maintain some of your records and file forms on your behalf — by hiring a registered agent, for example — or do them yourself. Either way, you’ll spend time keeping these files up-to-date.
One of the most important decisions you’ll make about your business is which entity type to form, but choosing the right one can be tricky.
Knowing the pros and cons can make this decision a little easier. Overall, corporations are such a popular entity type for a good reason, because they provide entrepreneurs with a formal business structure that’s fully prepared to grow with your company.
The corporation is more expensive and time-consuming to maintain than a limited liability company, for example, but the LLC isn’t nearly as investor-friendly as a corporation is, and it’s not as well-equipped for growth either.
On the other hand, the LLC can have a lower tax burden than a corporation does. It’s all up to you to determine which entity type best fits the unique needs of your business.
Things to Ask Yourself Before Forming a Corporation
Corporations aren’t for everyone. If you’re not sure whether you should incorporate or form a different legal entity, here are some important questions to consider.
They’ll help you determine whether or not a corporation is right for you.
1. How much confidence do you have in your business concept?
It’s impossible to predict just how the market will respond to a new business, but your gut might tell you that your business idea is perfect for your area. Being confident in your business concept is a good thing.
If you want to “test the waters” of whether or not your business will be successful, then you might want to start out as a sole proprietorship or general partnership before forming a corporation. Creating a corporation requires both time and money, so you may want to avoid those costs unless you’re sure your business will work.
On the other hand, there are liability issues with operating sole proprietorships and general partnerships, so if you are confident in your business model, you should probably go ahead and incorporate your business.
2. How much risk is behind your business?
The amount of risky activities you conduct may affect the entity type you form, and here’s why: someone has to pay up when something goes wrong at your business.
For example, let’s say that you run a skydiving business. You make safety a priority, but one day, a faulty parachute harness causes one of your patrons to break their ribs during a dive. If the diver with the broken ribs sues, who pays for the damages?
This scenario boils down to personal asset protection. If you operate a sole proprietorship or general partnership, then you would need to pay for the settlement personally, as your assets would be confiscated in the event your business couldn’t make the payment. A corporation, however, has personal asset protection thanks to the corporate veil, so the corporation itself would pay for the settlement, not the individual members of the corporation.
Businesses with a lot of risk for potential harm face a higher risk of paying settlements like these, and therefore these businesses should consider forming a corporation.
However, businesses with little risk might not find this protection as important. For example, if you run a one-person business offering web design services out of your own home, there is basically zero risk for injury settlements. The only reason these entities would want the personal asset protection would be for protection from potential debts incurred by the business.
3. How much control do you want over your business?
Your entity type affects the amount of autonomy you have in your business affairs. Sole proprietorships, for example, are controlled exclusively by the owner. While there are a few government regulations for these informal business structures, they’re not nearly as comprehensive as the rules and requirements for corporations.
Corporations must comply with a huge number of regulations at both the state and federal levels. In addition, the control of a corporation rarely stays with the original incorporator. If the corporation sells stock that also carries voting rights, then the control passes to the shareholders as well.
If you want exclusive control over your business, a single-member LLC might be a better option.
4. What are your plans for growing your business?
If you have lofty plans to grow your business quickly, then you’ll likely need an efficient way to raise capital. Corporations have the unique ability to sell stock, and issuing these shares allows a business to raise funds quickly. Other entity types would have to apply for a loan, or wait for their capital to increase through the natural flow of their enterprise.
Another area of growth you should consider is the number of people you want to bring into your business. Do you anticipate bringing in others as members or owners to gain their expertise, or do you simply want to hire employees? Your entity type affects how easy it is to add members to your business.
For example, adding members to an LLC requires additional paperwork, and a sole proprietorship would have to convert its entity type in order to add a new owner to the business. Corporations, however, have a much easier time changing or adding owners to the business, as a simple stock exchange can change its ownership.
Finally, if you intend to make shares of your corporation available to the general public, then you must form a corporation to do so. As we’ve already mentioned, corporations are the only entity with this privilege.
5. Are you okay with the drawbacks of forming a corporation?
Before you decide on a corporation, you should ensure that you’re both aware of and okay with the negatives that accompany this entity type. There are three primary drawbacks to consider.
The main disadvantage is the corporation’s obligation to maintain extensive corporate records and comply with legal requirements. As we alluded to earlier, there are a large number of rules to follow — simply reading these rules takes time, much less implementing them.
Corporations also have the disadvantage of heavier taxes than some other business types. Corporate income taxes can be quite high, and a few states charge both a corporate income tax and a gross receipts tax. In addition, C corporations are subject to double-taxation: the corporation’s income is taxed, and then the shareholders also pay taxes on the dividends they receive from the corporation.
A final drawback of a corporation is the sheer amount of time it takes to form and maintain one. Establishing good record-keeping habits can offset this, but you cannot avoid requirements like annual reports, quarterly tax payments, and more. If you can’t tolerate the paperwork, you may want to either hire someone to do it for you or choose a different entity type.
If these drawbacks don’t bother you, then the corporation may be the right entity for you.
Choosing your entity type demands careful consideration. This guide has walked you through the top five questions to ponder about whether a corporation is the right fit. Now that you’ve considered these questions, we wish you the best of luck as you form your new business.