One of the first steps of starting a business is choosing the best legal structure. You can choose to operate as a sole proprietorship, partnership, limited liability company (LLC), corporation or cooperative.
For many businesses, the best option is to file as a corporation. If you are considering this status for your business, keep reading to learn how to become a corporation.
Kelly DuFord Williams, founder and managing partner of Slate Law Group, outlined six general steps a small business must take to become a corporation. However, every state has specific guidelines, so your process may vary. Check the specific corporation requirements for the state where your business will operate.
If you can’t afford to hire an attorney, you can still file your applications and forms online or use third-party agents that offer direct services. However, Wendy Barlin, CEO of About Profit and author of Never Budget Again, warns business owners to be careful with these services, because a mistake as simple as checking the wrong box can have very expensive consequences.
If you haven’t already, you’ll also have to choose a name for your business when setting up your corporation. Most states require you to choose a name that isn’t too similar to one already used by another company.
The law observes a corporation as an entity separate and distinct from its shareholders (i.e., owners). A corporation has its own assets, liabilities and legal rights that protect its shareholders from personal liability.
A corporation can sue, be sued, own and sell property, and sell ownership rights via stocks. It’s also easier to transfer ownership and raise capital as a corporation because capital and ownership are raised and managed through stocks.
To be recognized as a corporation, your company must follow your state’s designated legal proceedings.
There are several corporation types, including C corporation, S corporation, B corporation, closed corporation and nonprofit corporation. Each corporation type has its own benefits, disadvantages and legal requirements. C corporations and S corporations are the most common.
Below are some basic details about each of these types of corporations.
A C corporation is a corporation with profits taxed separately from the shareholders’ business earnings. If you incorporate as a C corporation, your business receives limited liability protection. This means that if someone sues your business or your business files for bankruptcy, your personal assets cannot be seized as part of a ruling. Neither can those of your co-owners – and a C corporation can have an unlimited number of owners, more commonly known as shareholders.
Your C corporation must have a board of directors and a registered agent to act as the point of contact for any lawsuits against your company. Your board will oversee your company’s strategic direction, hire your managers and company officers, and attend shareholder and director meetings. These meetings must happen at least once per year, and you must always take meeting minutes to document them.
An S corporation is a corporation with profits passed through to the shareholders as personal income. This means that you and your co-owners avoid double taxation (taxes on both your business and personal earnings). You and the other business owners must pay yourselves reasonable salaries from your company’s profits.
Your company must have at least one and no more than 100 shareholders to qualify as an S corporation. You must also file taxes as an American corporation.
If your business applies for and receives B corporation certification, that means your company meets the highest possible standards of corporate social responsibility. These standards include social and environmental performance, legal accountability and public transparency. The nonprofit B Lab administers this designation to prioritize consumer demands for economic inclusivity and sustainability.
Notably, B corporations are not IRS or state-level tax structures. This designation has no bearing on your taxes, bylaws, meetings or allowed number of shareholders. B corporation status is solely an award that’s great for your reputation rather than a business entity type, despite including the word “corporation.” A B corporation will also be an S corporation, C corporation, partnership, LLC, or sole proprietorship.
Many businesses choose to be C corporations, since their unlimited number of allowed shareholders means the business can sell stocks. If your business does this, it would be a public corporation. Closed corporations are the opposite: private companies that are corporations with a set maximum number of shareholders, typically 35.
You might structure your business as a closed corporation if you run a partnership and want the liability protections of a corporation without any major business restructuring. You might also choose a closed corporation to avoid mandatory shareholder meetings and reporting obligations.
A nonprofit designation is typically reserved for companies benefiting the public or working to effect a specific cause. Nonprofit organizations may structurally resemble C corporations, but they must handle their profits differently. If your company is a nonprofit, you must funnel your profits toward your causes, employees’ salaries, or overhead and expenses.
All businesses formally classified as nonprofits are tax-exempt. Public charities and foundations, also known as 501(c)(3) organizations, are among the most familiar types of nonprofits. They’re non-political charities to which you can donate. Social or political nonprofits, also known as 501(c)(4) organizations, may also be familiar. Some trade and professional organizations are also nonprofits.
As you consider incorporating your business, you might have questions about how corporations differ from LLCs, sole proprietorships and partnerships. Below are the answers to some frequently asked questions about these business structure types.
There are distinct differences between these structures.
S corporations, C corporations and LLCs are often the safest types of business entities. These classifications ensure that your personal assets are protected if your business is sued.
Sole proprietorships, partnerships, and S corporations may be the best type of business entity for tax purposes. You’ll avoid C corporation double taxation with these types of business entities. However, for single filers making $41,775 or more, the personal federal income tax rate is 22%. As such, C corporation double taxation may actually lower your taxes if you cap your salary and keep most of your profits in your business.
Here are answers to some commonly asked questions about corporations.
A corporation’s shareholders (similar to the members of an LLC) are the people or legal entities who own the business. In most states, you only need one person to form a corporation, while the maximum number of shareholders varies by corporation type. For example, C corporations don’t have ownership restrictions, while S corporations are limited to 100 shareholders who must all be U.S. citizens.
Unlike other business entity types, a corporation protects each owner’s personal assets. When a shareholder invests money into the corporation, they receive a percentage of ownership, or shares, typically in proportion to their capital contribution.
“These shares entitle the shareholders to a pro-rata share of profits if the corporation is successful and makes money,” said Williams. “If the corporation loses money and is forced to liquidate, the shareholders are only liable for the amount of their investment – meaning they won’t get their money back, but any creditors the corporation owes money to cannot go after the shareholders’ other assets.”
There are pros and cons to forming a corporation. On the upside, the three biggest advantages of becoming a corporation are limited liability, business continuity, and access to funding.
On the downside, corporations face a lengthy process, rigid requirements and double taxation.
The incorporation of your business happens as soon as you file your articles of incorporation with the secretary of state. Although filling out the form may only take a few minutes, it could take weeks or even months to prepare all the documents you will need to file the articles of incorporation.
Articles of incorporation filing fees range from free to hundreds of dollars, depending on your state. Overall setup costs for a corporation also depend on your state as well as the type of corporation you need. You may also have to pay fees for your registered agent.
“Every corporation must have a registered agent for purposes of service of process,” said Williams. “There are professional registered agent companies that will perform registered agent duties for the corporation, and the annual fees will vary depending on the company.”
In short, no. Not every business will benefit from incorporation; some companies that become corporations are worse off than they were before. Becoming a corporation (and maintaining its status after that) requires time and money. It is essential to consult your lawyer and tax advisor before you take steps to incorporate.
“Maintaining the legal and income tax requirements of a corporation can be overwhelming for some business owners as well as expensive,” said Barlin. “I have some multimillion-dollar business clients who have chosen never to incorporate (even though they may save some money) because of the human costs of incorporating. The roles and responsibilities do not outweigh the tax savings and legal benefits for some business owners.”
To determine if incorporation is in your best interest, you must know your company’s goals and capabilities. For example, if you want to incorporate only for tax purposes, you may want to think again. Barlin said the same income tax deductions apply to unincorporated businesses. With a few exceptions, you can deduct any business expense that is considered “ordinary and necessary” for your business, irrespective of the entity type.
It can take a long time to incorporate your business, and maintaining your corporate status can be a challenge. But countless other businesses have done it time and again, and so can yours. Plus, the legal benefits and fundraising possibilities that corporate status brings may be worth the effort. Professional legal counsel and business consultants can help you navigate the process and decide whether or not to take the leap.
Skye Schooley contributed to the reporting and writing in this article. Some source interviews were conducted for a previous version of this article.