- A corporation is legally viewed as a separate entity from its shareholders (owners).
- The advantages of becoming a corporation include business continuity, access to capital and limited liability.
- To become a corporation, you will need to file articles of incorporation with your secretary of state.
- This article is for businesses of any size that want to incorporate.
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.
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.
- Hire a transactional attorney. An attorney can walk you through the business formation process. Corporate formation and governance laws vary by state and are constantly changing, so an experienced attorney will be invaluable in managing the formation process and avoiding problems.
- Appoint a registered agent and file the articles of incorporation. Every corporation must have a registered agent in the state where it files the articles of incorporation. A registered agent is an individual or company (i.e., a registered corporate agent) who will accept the required notice, also known as the service of process, if your corporation becomes a party to legal action. This agent must be a resident of the state where you filed.
- Create the corporate bylaws and appoint directors. Bylaws are the rules and internal regulations under which the corporation will operate (similar to an operating agreement for an LLC). Some states do not require corporations to have bylaws. However, it is prudent to adopt corporate bylaws, as they delineate the rights and responsibilities of your business’s shareholders, directors and officers, eliminating confusion and maintaining corporate formalities. Additionally, banks and creditors may ask to see your corporate bylaws to establish the corporation’s legitimacy before they extend loans or allow your corporation to open a business bank account.
- Issue stock. Shareholders who have contributed cash, services or other property to the business are entitled to stock (ownership interest) in the corporation in proportion to their contribution. A share of stock is classified as a security and generally falls under the requirements of state and federal securities laws.
- File any other necessary documents with your local secretary of state. Other documents may be required in your state. For example, when running a business in California, every corporation must file a statement of information within 90 days of incorporation and every year during the corporation’s filing period. Some states refer to this as the annual report. Filing requirements vary by state; some states do not require a statement or report to be filed until the following calendar year.
- File any necessary IRS forms. Every corporation must apply for an employer identification number (EIN). This is like a Social Security number for the corporation, so you’ll use it when your corporation applies for bank accounts and when you file corporate taxes. Filing by mail usually takes 30 days, but you can apply for an EIN online and receive one almost immediately.
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.
What is a corporation?
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.
What are the corporation types?
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.
1. C corporation
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.
2. S corporation
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.
3. B 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.
The best socially responsible businesses weave social responsibility into their business model, appealing to socially conscious consumers and employees while making a genuine difference in the world.
4. Closed corporation
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.
5. Nonprofit corporation
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.
Corporations vs. LLCs vs. sole proprietorships vs. partnerships
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.
What are the differences between sole proprietorships, partnerships, LLCs and corporations?
There are distinct differences between these structures.
- Sole proprietorship. A sole proprietorship is a non-corporation business with one owner. If your company is a sole proprietorship, your business income becomes part of your personal income and is taxed accordingly. You’re also personally liable if any lawsuits are filed against your business.
- Partnership. Partnerships work the same as sole proprietorships, but have more than one owner. A business partnership agreement typically outlines everyone’s roles and responsibilities.
- LLCs. LLCs are state-level designations that give sole proprietorships and partnerships limited liability protection. This means your personal assets remain protected – to an extent that varies by state – if your business is sued. At the federal level, your business remains either a sole proprietorship or partnership for tax purposes.
- Corporations. Corporations offer liability protections similar to LLCs while changing a company’s federal entity type. S corporations maintain sole proprietorships’ and partnerships’ pass-through taxation. C corporations’ profits are taxed separately and not as personal profit. Both types of corporation also introduce requirements for shareholders, boards of directors, corporate bylaws and regular meetings.
What is the safest form of business entity?
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.
What is the best business entity for tax purposes?
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.
No matter your business structure, payroll software can ensure you stay compliant with tax obligations. Visit our reviews of the best payroll providers to evaluate your options.
Here are answers to some commonly asked questions about corporations.
Who are the members of a corporation?
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.”
What are the advantages of becoming a corporation?
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.
- Limited liability. Since a corporation is its own legal entity, shareholders are not personally liable for company transgressions (except in circumstances like negligence), and their personal assets are safe from legal suit and debt collection. Although liability protection holds true in most cases, shareholders must follow their state’s specific requirements.
- Business continuity. Another major advantage of a corporation is the ability to maintain business continuity, regardless of who the owners are. Since a corporation is its own entity and ownership is transferred in the form of shares, it’s easier to transfer ownership (and percentage of ownership). This is especially useful when an owner wants to leave the corporation or in the event of a shareholder’s death.
- Access to funding. A corporation is often more expensive to maintain than other business entity types, but it is typically easier to raise large amounts of capital from multiple investors if you incorporate.
What are the disadvantages of becoming a corporation?
On the downside, corporations face a lengthy process, rigid requirements and double taxation.
- Lengthy process. The application process to become a corporation is often lengthy. The paperwork can be extensive as well. If your time is limited and you’re trying to minimize tedious work, you might not be ready to incorporate.
- Rigid requirements. Corporations are also subject to rigid structural, meeting and reporting requirements. You’ll need to create bylaws and regularly update them. You’ll also need to appoint a board of directors that meets at least once per year, and you must take minutes for these meetings, which can be tedious.
- Double taxation. If you incorporate as a C corporation, you’ll face double taxation. This means you’ll pay taxes on your business income and another tax on your shareholders’ percentage of profits earned. That won’t be your only expense – forming and maintaining a corporation is known to be expensive.
How long does it take to become a corporation?
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.
How much does it cost to set up a corporation?
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.”
Does every business need to incorporate?
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.
Becoming a corporation
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.