What is a corporation? How do you form one?
A corporation is an independent legal entity or business structure. Corporations are legal entities that can make profits, pay taxes, and be held legally responsible. Although they offer the greatest protection against personal liability for their owners, they are also more costly. Corporations are a good choice for high-risk companies and provide the opportunity to raise capital through stock sales.
We will discuss the benefits and drawbacks of forming a corporation. You’ll be able to decide if forming a corporation is right for your business.
Here’s an easy way to check if you should be thinking about a corporation.
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- You believe your business has a lot of potential for growth and that capital will be attracted to it in the future.
- Your business has moderate to high risk
- You are organized and self-starting.
A corporation may be an option if any of these apply.
What is a Business Formation Structure?
The decision to form corporation has a major impact on your business in three main ways: legal liability, taxes for the owner, and taxes for the business itself.
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After balancing these factors, and determining the benefits and protections that they provide, the business owner will file the chosen form when registering their business with the secretary of state. These are the most popular forms of ownership:
- Limited Liability Company
- Sole Proprietorship
There are many factors that will determine which type of business formation is best for your company. Depending on the organization’s size, there are different legal business formations that provide taxation and legal protection. While owners can modify the business structure to accommodate the growth and formalization of their business, specific regulations vary from one state to the next.
It’s not surprising that larger companies choose to restructure or structure as corporations. A larger bubble of protection is more sensible than a smaller one like a limited liability corporation or sole proprietorship.
However, extra corporate protection comes with a higher filing fee and taxation, as well as more detailed record-keeping and operational discipline. If you are looking to grow your business or plan to start one, it is the best option.
The US witnessed an increase in business formations by 82% in the third quarter 2020 compared to the same time in 2019. This was accompanied by a staggering 1.56million applications. The highest application rates were in the Midwest and South.
How to form a corporation
Your local secretary of state office (SoS) website is a great resource for companies looking to form a corporation. This is where you will submit all your paperwork and business filings. It can also be a great resource for business owners looking to make informed decisions.
You can do the formation process yourself (more details below), but there are many attorneys and resources online that can help you make it easier. The process of forming a corporation follows a few standard steps.
The Articles of Incorporation, which are required paperwork to register a corporation with the secretary of state, are required. Your business isn’t legal until you have completed this process.
a) Choosing a Corporate Name
The articles of incorporation must include the business name. You should check your SoS website before you file a name. Otherwise, it could be difficult to find the name later.
b. Appoint a Statutory Agency
Another requirement for the business is to file the articles of incorporation. The statutory agent, at its core, is the person or organization responsible for receiving and dealing with important mail. This usually pertains to taxation and legal proceedings, secretary-of-state correspondence, and other correspondence related to the business entity. The statutory agents are typically the business owner, the attorney of the company, the accountant of the company, or any third-party company involved in acting as a business statutory agent.
2. 2. Authorize shares of stock
This is where you can determine how many shares you want to issue, to whom and at what price pershare.
3. Get Licenses, Permits and IDs.
These documents, licenses, and certificates will vary depending on the state in which you operate. They may include your Tax ID (aka EIN) and ID numbers for unemployment, disabilities, and payroll taxes.
The board of directors is responsible for the organization’s governance. It is charged with issuing stock and electing mandatory officers (the corporation must also have a president and secretary), as well as overseeing strategic and organizational decisions.
An attorney can help ensure that all the tasks and materials are completed correctly and responsibly. An attorney, or online legal help, can assist you in drafting initial protective documentation such as shareholder agreements, board bylaws, and other policies.
Delaware, Nevada and Wyoming are some of the most business-friendly states. They either have a large percentage of American corporations, or they are very flexible with filings.
Did You Know?
These are the five states that saw the greatest increase in filings for business formations between 2018 and 2020:
North Carolina (+4.8%)
South Carolina (+4.4%)
How much does it cost to form a corporation?
Each state has its own incorporation fee, rules and regulations for annual reports, as well as the annual report filing fee. These are the key states that require corporate filings. Here’s a breakdown of what it will cost to file there.
|State||Incorporation fee||Annual Report Filing Fee|
|Nevada||Start at $75||$150|
|Wyoming||$100||Start at $50|
(Source: sos.state.gov per state site)
Corporation Tax Obligations
As mentioned above, the legal protection provided by corporation formation is about equal to that of the law. But, this comes with a price. This formation not only results in a higher formation fee and filing fee for the annual report, but also a higher tax.
It works like this: corporations pay income tax on profits. Not only that, but in a C corporation formation, shareholders/investors are taxed a second time on their personal tax returns depending on the dividends they draw. Double taxation is a term used to describe this. C-corps are also subject to both federal and state corporate taxes rates. These rates vary depending on the taxable income. Find out more about the current federal and state tax rates.
However, there is a Plan B for corporate formation and avoidance of double taxation. An S corporation is one type of corporation. It is the clearest way to avoid double taxation. S-corps allow profits not to be subject to corporate taxes to flow directly to owners and shareholders. S-corps may not be recognized in certain states. For more information, visit the website of your secretary and review its policies.
Benefits of forming a corporation
It is advantageous to form a corporation. There are also perks to creating an organizational structure in this manner. These are the highlights:
Limited Liability Protection
Like an LLC (limited liability corporation), the personal assets of both shareholder and owner are protected against liability for business obligations. This means that ownership and the business are treated as separate entities. If the business fails or is in financial distress, the ownership will not be responsible for the debts.
Corporations are the most formal form of business and have a lot of cache. This is attractive to potential buyers and stakeholders. This is also a way for owners to hedge their bets if they anticipate significant growth.
Easy Access to Capital
Corporations enjoy greater capital injection and investment consideration, which can be a way to piggyback on the credibility perk. A corporation also has the option to “go public”, by selling shares of its company on the stock market. This is a great way to gain capital and visibility.
Fluidity in Ownership
The corporation is independent from its owners, so it can survive ownership changes and turnover with relative ease. A corporation can survive to the end, while other business structures may cease or dissolve at their will. We’ll also discuss the downsides below.
The disadvantages of forming a corporation
Like any other decision, there are trade-offs to be made when choosing a corporate structure. These could include:
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- Double taxation (depending on the situation)
There’s the double taxation issue, as we have already discussed. In some cases, this can be avoided by filing as an S-corp rather than a C-corp.
- There is a lot of red tape
The formalities of operation are also part of the “Corporate” label. These obligations include the filing of annual reports with the state and the compliance with strict record-keeping requirements. They also require the holding of annual shareholder meetings and the management and support of a team consisting directors, officers, shareholders, and employees.
- Fluidity in Ownership
Fluidity of ownership in corporations can be a double-edged weapon. If hundreds of shareholders are involved in the company’s success, but not for financial gain, it can lead to turnover in governance and management and a lackluster, mission-driven work environment. This can lead to discordance from the original vision.
There are many factors that influence the decision to form a company. These include how risky it is, how many shareholders it has, its operations, growth potential, etc. Consider your options and do your research. If you are unable to decide, get legal help. Starting a business is a lot of work. However, once you have decided whether to go corporate or not, the hard work can be done.