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What exactly is a “corporation”?
At the most basic level, a corporation is a legal entity that is separate from its owners.
You might hear lawyers sometimes referring to corporations as legal “persons.” All they mean by this is that corporations are not an extension of you or any other person—they exist in their own right. This is important mainly because it gives them a superpower called limited liability or liability protection.
With limited liability, owners of a corporation do not have personal liability for business debts. Their personal assets are completely protected against a corporation’s creditors. In a nutshell: if a corporation borrows money and then loses it all, the people it borrowed money from can’t come after its shareholders or their assets.
When you put money into and become a shareholder of a corporation—say by buying $1,000 worth of stock—you’re only on the hook for that amount ($1,000) and no more.
Why should you incorporate?
Limited liability is usually the main reason why people form corporations, but there are also other reasons.
It formalizes the business
If there are multiple owners involved in your business, going through the incorporation process gives each of you a chance to evaluate the business and spell out responsibilities more clearly.
One of the biggest decisions business owners have to make when incorporating is figuring out an equity split—or, how much of the business each owner will get to keep. Do you feel like you’re doing the lion’s share of the work in your business? Now is the chance to bring that up with your co-founders and come up with an equity split that reflects that.
It (might) lower your tax bill
Corporations are also considered to be separate taxpayers, and often pay tax at a special corporate tax rate that is different from (and often lower than) individual tax rates. This is especially true under the new Trump Tax Reform.
It opens the business to investment
Incorporating makes it a lot easier for others to invest in your business, mainly because it lets you issue stock (i.e. shares in the company) and have shareholders. Investors are a lot more willing to give you money if they get a stock certificate in exchange for it, rather than a simple handshake or IOU.
It makes you look official
Incorporating also signals to investors, employees and the public that your business is legit and that it’s serious about growing. Wouldn’t you rather do business and sign a contract with a corporation than with Ricky Bobby with a hotmail address?
What are the different kinds of corporation you can form?
Generally speaking, there are two popular kinds of corporations that small businesses form: C corporations and limited liability companies (or LLCs for short).
C corporations
C corporations are the standard “vanilla” format for corporations. If you’ve filed a certificate of incorporation with your state, had it approved, and haven’t turned your corporation into an LLC or S corporation, you’re probably running a C corporation.
C corporations have shareholders who own shares in the company, board members who make decisions about the direction of the company on behalf of the shareholders, and officers who manage the company day to day (like the CEO and the CFO).
When C corporations pay taxes, they do so separately from their owners, and are taxed at a special corporate tax rate. (For more information about paying taxes as a C corporation, check out the IRS website.)
Limited liability companies (LLCs)
An LLC—“limited liability company” or “limited liability corporation”—is a business entity that behaves like a corporation at the state level, but is taxed like a partnership or sole proprietorship at the federal level.
Unlike C corporations, LLCs don’t pay corporate income tax. They avoid double taxation—that is, they avoid getting taxed when they earn income, and then again when profits are distributed to owners. Instead, the profits (or losses) of an LLC “flow through” to its owners, and are taxed only once.
LLCs are also structured differently than C corporations. Instead of shareholders, board members and officers, LLCs have members who both own the business and run it day to day.
Because they’re created at the state level, the rules for LLCs vary by state. In most states, there’s no maximum or minimum number of members for an LLC—you can have one, like your local veterinarian office, or thousands, like Google LLC does.
Suggested resource: C Corp vs. LLC: Which Is Better for Early-Stage Entrepreneurs?
What about S corporations?
S corporation—short for “Subchapter S corporation”, or sometimes “Small Business Corporation”—is a special tax designation granted by the Internal Revenue Service (IRS) that lets corporations pass their corporate income, credits and deductions through to their shareholders.
S corporations don’t pay income taxes. Instead, the company’s individual shareholders split up the income (or losses) amongst each other and report it on their own personal tax returns.
“S corporation” is a tax designation, not a business entity type. You can’t ‘incorporate’ as an S corporation. To become one, you have to create a C corporation, and then apply to the IRS for S corporation status.
So how do I form a corporation?
There are a few things you need to keep in mind before starting the incorporation process:
- The whole thing takes at least a few weeks to do, so give yourself plenty of time
- Some of these steps will also involve mail or the use of a fax machine
- Don’t do anything below before consulting a lawyer specializing in incorporating small businesses
Step 1: Pick your type of corporation
The first big decision you need to make is whether to form a C corporation or an LLC. Which business entity is right for you will depend entirely on your particular business situation, and you should definitely consult a lawyer before making that call.
Speaking very generally, however, C corporations tend to be better for companies that are focused on growing quickly and raising money from external investors, whereas LLCs tend to be better for businesses that are focused on lowering their tax burden.
If you’re looking to establish an LLC, check out our guide to forming one here. Continue below for a step-by-step guide to forming a C corp.
Step 2: Pick a state to incorporate in
Different states have different rules around corporations, which is why picking the right state to incorporate in is crucial.
Ever wonder why so many companies decide to incorporate in Delaware? It’s mainly because of the state’s flexible rules around corporations and generally business-friendly environment.
Read up on your state’s rules around incorporation, compare tax rates across state lines, see what the general trend is in your industry, read up on the tax advantages of filing in Delaware, and most importantly, talk to a lawyer to find the best fit for you.
Step 3: Pick a name
The next step is to pick a name for your corporation that hasn’t been taken by any other company in the state you’re filing in. Use your state’s business registry to look up whether the name you’re considering is taken (here’s Delaware’s registry and here’s California’s).
Run a Google search too, especially if you expect to do any business out of state. Double-check to see that it doesn’t include any words that are restricted by your specific state (“insurance” is restricted in certain states, for example).
If you plan on doing business under a different name than your legal one, consider filing a DBA.
Step 4: File articles of incorporation with your state
Your company’s articles of incorporation are a simple signed document that states your business name, the names of its members, and the business’s address. Here’s what the one for Delaware corporations looks like. LLCs will provide the same information and the name of a registered agent on articles of organization.
Where you file this document varies by state, so consult your state government’s website for information about state fees and where to file. Typically you’ll file with your secretary of state and need to pay a filing fee for the nging from $100 to $800 depending on where you incorporate.
These documents must be completed by an incorporator. An incorporator is whoever will be responsible for handling all communication throughout the process. They do not need to be a part of the business, they can be a representative like an attorney.
Within a few weeks, your state should get back to you with a letter officially certifying the creation of your corporation. Congrats! Now keep everything together in your corporate records in case you need to refer back to anything.
Step 5: Adopt a set of bylaws for your incorporation
Your corporation’s bylaws lay out all of your corporation’s rules around ownership, responsibilities, shareholder voting rights, salaries, when the fiscal year ends, who’s on the hook for taxes, how profits are distributed, what happens if the business fails, and so on.
When you go to an expert for help with incorporation (again in most cases this will be a lawyer) crafting bylaws that fit your business’ specific needs will be what you spend most of your time on.
LawDepot’s handy corporate bylaws generator should give you a sense of what goes into a typical set of bylaws, but again, make sure to talk to a lawyer about this. (Founders Workbench also offers handy tools for generating all kinds of legal documents.)
Step 6: Elect a board of directors
One thing you’ll lay out in your corporation’s bylaws is the size of your board of directors, which governs the corporation and makes important decisions about its operations.
Your board will have to hold regular meetings to make important decisions about the future of the corporation, and one of the first actions it will take is to issue shares and appoint officers.
Step 7: Issue shares
Shares are small pieces of your company that are worth a certain dollar value. If you total up the value of all the shares you own, that’s your total “stock” in the company.
The board of directors can issue shares whenever, to whomever, and for whatever value it wants. And when your company incorporates, it has to call a board meeting to decide how many shares each of the company’s original owners will get.
It’s a bit like when you and a business partner decide what percentage of an unincorporated partnership you’ll each own, but more official.
Step 8: Appoint officers
Officers are people responsible for the day to day operations of the company. Usually they have official-sounding titles like “chief executive officer,” “president” and “treasurer.” For most smaller C corps, directors will usually also be officers (and shareholder) in a company.
Step 9: Secure any licenses and permits you need
The rules for corporate licenses and permits vary a lot depending on your state and industry. Check with your state and get the proper business licenses and permits for your newly registered corporation.
Step 10: Get an Employer Identification Number from the IRS
The IRS uses your Employer Identification Number (EIN) to track your business for tax purposes, and you need one even if you don’t have any employees.
You can get an EIN two ways:
- By filing Form SS-4 (see the IRS’s instructions to SS-4 here)
- By applying for one using the IRS website here
If you’ve talked to an expert and decided that your corporation will be better off taxed as an S corp, you’ll also have to file Form 8832 or Form 2553, respectively. (Don’t do this unless an expert tells you to.)
Step 11: Sign up for payroll tax payments with the IRS
You can do this over the phone by calling the IRS directly at 1-800-555-3453 (EFTPS Pin and bank account info ready), or online here. You’ll also have to create a password for your Electronic Federal Tax Payment System account, which you’ll then have to log into here.
Step 12: Sign up with Social Security Business Services Online (SS BSO)
You’ll need to do this to complete your Federal W2 filing with Social Security. You can do that at the Social Security Administration’s website here, and you can find a handy guide to filling out the form here.
But wait, incorporation isn’t for everyone!
Not every business benefits from incorporation. If your business is still in the hobby stage, not looking for investment, and not particularly interested in formalizing its leadership structure, incorporation can be more of a distraction than anything. Just remember:
It’s expensive to incorporate
Compared to other business structures like sole proprietorships (which you start automatically just by doing business) and partnerships (which you can form with a simple handshake agreement), it’s expensive to start and run a C corporation. Depending on how and where you incorporate (and whether you go to a lawyer for help, which, again, you absolutely should) the whole process could cost you thousands of dollars.
It involves lots of regulation and paperwork
C corps have to follow many regulations at the federal, state, and local level. If you incorporate as one, you’ll probably have to do a lot more paperwork than you would operating a partnership or sole proprietorship. Plus remember that when you incorporate, that’s a whole new set of financial and tax records that you have to keep track of, which could suck up a lot of your time.
It might cost you more in taxes
Incorporation can actually leave many businesses with an increased tax burden. Corporations don’t have access to the same credits that individuals have on their personal tax return, and if you incorporate, you can’t reduce your personal income by any losses you sustain—you’ll have to carry them forward into another tax year.
If you decide to incorporate, get familiar with every corporate tax deadline so you don’t miss a single due date.
