- A corporation is legally viewed as a separate entity from its shareholders (owners).
- 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 in starting a company is to establish a legal business 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 for your business, keep reading to learn how to become a corporation.
What is a corporation?
The law observes a corporation as an entity that is separate and distinct from its shareholders (owners). A corporation can have its own assets, liabilities and legal rights, which protects its shareholders from personal liability. A corporation can sue, be sued, own and sell property, and sell ownership rights via stocks. In addition to the liability protection, it is 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 the proper legal proceedings for your state. There are several types of corporations, 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.
Key takeaway: A corporation is a legal entity separate from its shareholders, shielding you and the other owners from personal liability.
How to become a corporation
Kelly DuFord Williams, founder and managing partner of Slate Law Group, outlined the six steps a small business can take to become a corporation. However, each state has its own guidelines for becoming a corporation, so your process may look slightly different. Check the specific requirements for the state where your business will operate, but in general, these are the basic steps that most businesses need to follow.
- Hire a transactional attorney who 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 any issues.
- 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. This is the individual or company (i.e., registered corporate agent) who will accept the required notice, also known as the service of process, if your corporation becomes party to a 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 legitimacy of the corporation before extending loans or allowing your corporation to open accounts.
- 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. For example, in California, every corporation must file a statement of information within 90 days of incorporation and then every year during the corporation's filing period. Some states refer to this as the "annual report," and the filing requirements vary by state, with some states not requiring 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 the recently released 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.
Key takeaway: To become a corporation, you will need to hire an attorney, appoint directors and a registered agent, create bylaws, issue stock, and file articles of incorporation and IRS forms.
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?
The three biggest advantages of becoming a corporation are limited liability, business continuity and access to funding. 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 need to follow their state's specific requirements.
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 is 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.
A third advantage to forming a corporation is access to capital. 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.
How long does it take to become a corporation?
The incorporation of your business happens as soon as your articles of incorporation are filed with the secretary of state. Although filling out the form for the articles of incorporation 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 $50 to $300, but the overall setup costs for a corporation depend on the state you are incorporating in and the type of corporation you need.
For example, Williams said the filing fee for the articles of incorporation in California is $100 for a for-profit corporation and $30 for a nonprofit corporation, and the filing fee for the statement of information is $25 for a for-profit corporation and $20 for a nonprofit. If the corporation is filing a 25102(f) with the California Department of Business Oversight, the fee is $25 to $300. 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; in fact, some that become corporations are worse off than they were before. Becoming a corporation (and maintaining its status thereafter) requires a lot of time and money. It is important to consult your lawyer and tax advisor before you take the 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 need to know your company's goals and capabilities. For example, if you are simply trying to incorporate 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 "ordinary and necessary" for your business irrespective of entity type.