As opposed to other types of business entities, a corporation has a separate and distinct legal existence from its owners. The law treats corporations as if they are “people,” allowing them to take on liabilities, enter into contracts, sue and be sued in their own names, and pay taxes separately from their owners, which are called shareholders.
Because of this trait, corporations may continue in existence indefinitely. Therefore, corporations only end when they are legally dissolved under state law, not when the owners change or die.
The last important characteristic of corporations is that their owners have limited liability. This means that the owners may not be held personally liable for their company’s debts unless they agree. Instead, the corporation itself is responsible for repaying debts as well as paying off any legal judgments that may be awarded against it.
The first step to legally form a corporation is filing the “articles of incorporation” with the office responsible for business filings (usually the Secretary of State’s Office) in the state where you wish to form the company. In some states, this document is known as a “certificate of formation” or “certificate of incorporation.”
To complete the articles of incorporation, you will need to pay a fee, normally $100–$500, depending upon the type of corporate entity you are forming. You will also need to include the following information with your articles:
Lastly, state law requires that your company follow certain corporate formalities. Most states require that companies create a set of corporate bylaws that set forth the general management structure of the company as well as broad procedures of corporate governance. Also, states typically require that the company hold an initial meeting of the board of directors in order to show that the company is formally initiated to conduct business.
Other required corporate formalities vary from state to state. You can find the particulars for your state by visiting your Secretary of State’s Office or a similar corporate governance website provided by your state of incorporation.
A board of directors is the group of individuals elected as representatives of shareholders and company management to make important company decisions and establish major policies. Boards are responsible for hiring and firing executives, establishing executive compensation, monitoring company performance and auditing financial indicators, and setting overarching company goals. Basically, the board must do whatever it can to look out for the best interests of the company and its stakeholders.
The board of directors is normally elected at the first shareholders' meeting and may be comprised of shareholders, executive officers, key management personnel, and outside members with valuable expertise. The size and exact composition of the board of directors will depend on the company’s needs and circumstances. Ideally, the board is balanced between internal and external members that can adequately represent the interests of the management, the shareholders, and the company itself.
Corporate officers are elected by the board of directors. Most companies have at a minimum a president or CEO (chief executive officer), one or more vice presidents, a secretary, and a treasurer. State law establishes which officers are required and which are optional.
All officers have a basic duty to act for the best interests of the company and its shareholders within the context of their positions. This is why many large companies often have hundreds of officers. The CEO is accountable to the board of directors for the overall performance of the company.
State law also requires that a treasurer, or CFO (chief financial officer), be responsible for maintaining accurate company financials in compliance with any and all applicable regulations. Lastly, the secretary is tasked with safekeeping all company records, including shareholder and board meeting minutes and resolutions, corporate bylaws, tax and other governmental filings, licenses and permits, major contracts, and stock transactions.
There are four main types of corporations: C corporations, S corporations, nonprofit corporations, and professional corporations. Although sometimes confused as a corporation, an LLC is a hybrid entity that shares some characteristics of both corporations and partnerships.
C corporations, or C corps for short, are what most people think of when they think about corporations, and these are by far the most common type of corporation.
S corporations, or S corps for short, are corporations that have elected to be taxed as a “pass-through entity” under Subchapter S of the IRC. This means that, as opposed to a C corporation, an S corporation is not taxed separately from its owners (known as “double taxation,”). C corps and S corps are explained in more detail below.
Nonprofit corporations are formed for charitable, educational, religious, literary, or scientific purposes, not in order to earn profits for its shareholders. As such, they differ from other corporate entities in a number of important ways, including being exempt from taxation, prohibited from paying shareholder dividends, and prohibited from engaging in significant lobbying and political campaigning.
Professional corporations are used as the entity type for specialized professions such as doctors, lawyers, accountants, architects, and other licensed professionals. State law has special filing requirements for professional corporations.
Another name for a C corp is a “general for-profit corporation.” Like all corporations, the shareholders own the company and elect the board of directors, which in turn elects the corporate officers.
The major distinguishing feature of a C corp is that it is taxed separately from its owners. With certain exceptions, distributions to shareholders from earnings are treated as dividend payments for federal tax purposes.
The shareholders have limited liability for the debts and obligations of the company. This means that, except for in rare circumstances, the shareholders may not be held personally liable for company debts, leaving only the corporation’s assets at risk in the event of a suit against the company.
C corps may have an unlimited number of shareholders and may exist for an unlimited duration unless the articles of incorporation or bylaws state otherwise. Therefore, the corporation will continue to exist if the owners change or die. Also note that C corps may be owned by other businesses.
S corps are the same as C corps except that they have elected a special tax status under Subchapter S of the IRC. They are still structured the same as C corps, with shareholders, a board of directors, and corporate officers functioning the same.
Their special tax status means that they are NOT taxed separately from shareholders. To achieve this tax status the company must meet certain requirements.
As mentioned above, the major difference between the two entities is that a C corp receives double taxation on income, while S corp income is only taxed at the individual shareholder level.
Other important distinctions include C corps, unlike S corps, may have other businesses as shareholders. C corps have no restrictions on the number of shareholders or classes of stock, while S corps have the shareholder restrictions mentioned above and may only have one class of stock.
Practically speaking, what this means is that C corps are less restricted and have more room to grow; however, S corps will make more sense for businesses that do not expect to need such flexibility. Keep in mind that you can always switch between entity types later on down the road by filing the appropriate paperwork with your state.
LLCs, unlike S corporations, may have other businesses as shareholders and do not suffer from the other ownership restrictions on S corps. For instance, LLCs may have an unlimited number of members, while S corps are limited to no more than 100 shareholders. Furthermore, prior approval from other members is typically required to transfer or sell an ownership interest in an LLC, while S corp stock is freely transferable assuming any ownership and transfer restrictions are met.
LLCs do not have to follow as many corporate formalities as S corps, which must adopt bylaws, issue stock, hold initial and annual board of directors' and shareholders' meetings, and maintain appropriate corporate records.
LLCs, on the other hand, mainly follow optional formalities according to their business needs. For instance, states do not require that LLCs create or file operating agreements; however, such agreements are often useful for outlining the management structure and general policies of the company.
S corps follow the standard corporate structure, with a board of directors electing officers that are responsible for managing the day-to-day operations while the board stays largely out of the picture except for major company decisions.
LLCs that are member-managed tend to act more like partnerships, since the owners themselves are instrumental in management. However, LLCs that choose to elect one or more managers to handle operations are more similar to corporations, since there is more division between the member owners and the managers.
Income earned by C corps is taxed twice: once at the entity level when the corporation pays its taxes and once again at the personal level when that income is distributed to shareholders as dividends or salary. This is what is known as “double taxation.”
Double taxation is the result of corporations being treated as separate entities from their owners. This separation is one of the key features that allow corporations to be held liable separately from their owners, shielding the owners from personal liability for corporate debts and obligations. However, one of the drawbacks of this is that the corporation is taxed for its income in the same way individuals are.
Once you have figured out your desired entity type, you will need to go online to view your particular state’s formation requirements. This is recommended even if you are using a third-party online service to help you incorporate. This will help you comply with any ongoing requirements you will be responsible for meeting after the incorporation stage.
If you are using a third-party service such as LegalNature to help you set up your business, simply provide your information when prompted, and the service should handle the rest of the filing and send you confirmation and any further instructions if your company is approved by the state.
One important choice you will make at this stage is whether to use a registered agent service or act as your own registered agent. A registered agent is the person or service your company designates to receive any service of process when your company is part of a legal action. All companies are required to have a registered agent in the state of incorporation that is available for service during normal business hours.
There are pros and cons to each option. For instance, acting as your own registered agent is usually less expensive, whereas most registered agent services cost $150–$300 per year. However, using a registered agent service avoids the negative consequences associated with being served with lawsuits in front of employees and customers. It is also imperative when your company does not have an office in its state of incorporation.
Many states also offer expedited filing of your articles of incorporation or other formation documents. This normally costs an additional fee, but may be extremely helpful if your business needs to be set up and get to market fast.
Corporate bylaws are a company’s internal rules governing the internal management, structure, and operating procedures. Almost all states require companies to memorialize their corporate bylaws in a written document to be approved at the company’s first shareholders' meeting. Many states also require companies to file the bylaws with the Secretary of State’s Office or other governing body.
Even if your state does not require your company to create bylaws, it is still highly recommended that you do so. This will go a long way to avoiding potential disputes and conflicts between shareholders down the road. Most business owners and attorneys consider the bylaws (or operating agreement for LLCs) to be the most important document for any company, regardless of entity type.
Specifically, the corporate bylaws will include at a minimum the official name and general purpose of the company, the shareholder voting rights and removal process, the composition of the board of directors, as well as identify any committees, name officers, explain how meetings will be conducted, and provide instructions on dealing with any conflicts of interest between shareholders and the company.
A shareholder agreement defines all shareholders' rights, duties, privileges, and protections. It normally includes language to safeguard the company owners and their dividend distribution rights, voting rights, management rights and responsibilities, and more. Although not technically required, this document provides the shareholders with much greater protection than the articles and bylaws alone.
Corporations are required to keep meeting minutes of all shareholders' and board of directors' meetings. Meeting minutes are simply an official record of the topics discussed and actions taken at such meetings. During a company’s first official shareholders' meeting, certain actions are normally taken in order to officially make the company open for business.
After introductory formalities, the company will officially adopt the articles of incorporation, any bylaws, stock certificates issued, and other documents agreed upon at that time. Resolutions will also be passed to appoint the officers specified in the bylaws, adopt any corporate seal, specify the start and end date of the company’s fiscal year, issue shares, and agree on an entity tax status.
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