A corporation is a legal entity and business structure that is completely independent and separate from its owners. Corporations can make a profit, be taxed, and are legally liable. They offer the highest level of protection for its owners from personal liability but are a more expensive formation. Corporations make sense for high-risk businesses and offer the benefit of raising capital by selling stock.
We’ll discuss how and why to form a corporation, the costs and trade-offs of doing so, and the advantages and disadvantages that will influence this structure. By the end, you’ll know whether or not a corporation formation makes sense for you and your business.
But here’s a quick self-check to see if you should even be considering a corporation:
- Your business has lots of growth potential and you hope to attract capital, sell, or go public in the future
- Your business is moderate to high-risk
- You are extremely organized, self-starting, and/or have a team that is
If any of these apply to you, a corporation might be an option.
Why a Business Formation Structure?
For the most part, the decision to form a corporation affects three major factors in your business: legal liability, owner taxes, and the actual business taxes.
Upon deciding the right balance of these three factors and their corresponding protections and benefits, the business owner will file their chosen formation when registering the business with your secretary of state. The most common forms of ownership structure are:
- Limited Liability Company
- Sole Proprietorship
The type of formation that makes sense for a business depends on a number of situations. The various legal business formations represent different levels of legal protection and taxation for an organization depending on its size. Owners can change the business structure as the business grows and formalizes, although specific regulations vary by state.
There’s a reason why larger businesses choose to structure (or re-structure) as a corporation. As more assets, people, and risk hang in the balance, a larger, safer bubble of protection starts to make more sense than a smaller initial formation like an limited liability corporation or a sole proprietorship.
With extra corporation protection, however, comes a higher price tag (for filing and for taxation), and more meticulous record-keeping, and operational discipline. It’s the best formation if you plan on (or already have) a large business, intend to publicly trade shares, or are trying to become attractive to investors for continued growth.
In the News:
By the third quarter of 2020, the US saw an uptick in business formations of 82% from the same period in 2019. This included a staggering 1.56 million applications, with the heaviest application rates in the Midwest and the South.
How to Form a Corporation
A great guide for businesses exploring formation of a corporation is your local secretary of state (SoS) office or website. Not only is that where you’ll submit all of your business filings and paperwork, this resource can offer information to help business owners make the most informed decision.
While you can dredge through the formation process on your own (more information on that below), there are droves of attorneys and online resources to assist and make the process a little more painless. There are some standard steps to getting any business legal, but the specific process for forming a corporation is as follows:
1. File Articles of Incorporation
The Articles of Incorporation are the collection of paperwork required to form a corporation with your secretary of state. Until you complete this process, your business doesn’t legally exist in the eyes of the state.
a) Choosing the Corporate Name
The business name must be determined and included in the articles of incorporation. Before filing a name, check on your SoS website to make sure that name is available, or you may be in for a very inconvenient name change later.
b) Appoint a Statutory Agent
This is another requirement of the business upon filing the articles of incorporation. At its core, the statutory agent is the person or corporation responsible for receiving and handling important mail and related correspondence, which typically pertains to taxation, legal proceedings, secretary of state correspondence, or other correspondence pertaining to the business entity. The statutory agent is typically one of the business owners, the business’s attorney, the business’s accountant, or a third-party company that is in the business of acting as a statutory agent for business entities.
2. Authorize Shares of Stock
Here’s where you determine how many shares of stock you intend to issue, to whom, and at what price per share.
3. Apply for Licenses, IDs, Permits, and Certifications
Depending on your business and your state of operation, these various documents, licenses and certificates can include the business’s Tax ID (aka EIN), and ID numbers for unemployment, disability, and payroll taxes.
4. Appoint a Board of Directors
The board of directors acts as the organization’s governance, and is in charge of issuing stock, electing mandatory officers (the corporation must have a president, a secretary, and a treasurer), and overseeing major organizational and strategic decisions and direction.
Working with an attorney can ensure that the above required materials and tasks are undertaken responsibly and accurately. Furthermore, an attorney or online legal assistance can help you draft initial protective documentation like shareholder agreements, board of directors bylaws, and various other policies.
Some uniquely business-friendly states that either hold a substantial percentage of American corporations or are particularly flexible in filings include Delaware, Nevada, and Wyoming.
Did You Know?
The five top states with the largest increase in business formation filings of 2018-2020 include:
North Carolina (+4.8%)
South Carolina (+4.4%)
Costs to Form a Corporation
Every state has its own assigned incorporation fee, its own rules and regulations regarding annual reports, and the annual report filing fee. Here are a few key states for corporate filings and the breakdown of what it’ll set you back to file there:
Annual Report Filing Fee
Starting at $75
Starting at $50
(Source: sos.state.gov per state site)
Tax Obligations of Corporations
As previously mentioned, corporation formation provides about as much legal protection available under the law. However, that comes at a cost. Not only is the formation fee and annual report filing fee higher than with other business structures, this formation results in the highest taxation.
The way it works is that corporations pay income tax on their 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. This is known as double taxation. Plus, C-corps are subject to federal and state corporate tax rates, which vary depending on taxable income. Learn more about current federal and state taxation rates.
There is a Plan B when it comes to corporate formation and avoiding double taxation, however. One type of corporation is called an S corporation, and it is the clean and clear solution to avoiding double taxation. S-corps allow profits to pass through directly to shareholders’ and owners’ personal income without ever being subject to corporate taxes. In some states however, S-corps are not recognized, so be sure to read your secretary of state website and its policies on formation.
Advantages of Forming a Corporation
There are advantages to forming a corporation and perks to setting up your organizational structure this way. The highlights include:
Limited Liability Protection
Just like with an LLC (limited liability company), owner’s and shareholder’s personal assets are protected from liability of the business obligations. That is, ownership and the business are considered separate entities, and if the business goes under or faces financial hardship, ownership won’t be responsible for its debts.
Corporations are the most formal business structure, and come with a certain level of cache. This appeals to potential investors, buyers, and stakeholders. It’s also a way owners hedge their bets when they expect significant growth of the organization.
Ease of Access to Capital
To piggy-back off the credibility perk, corporations enjoy more serious investment consideration and capital injection. Furthermore, a corporation has the attractive option of “going public,” by offering shares of the company on the stock exchange. This presents a substantial opportunity for capital gain and visibility.
Fluidity of Ownership
Because the corporation is separate from its ownership, a corporation can survive turnover of shareholders and ownership with relative ease. This means that a corporation can exist in perpetuity, whereas other business formations may die or close at the whim of ownership. However, we’ll cover the disadvantages of this as well below.
Disadvantages of Forming a Corporation
As with anything, choosing a corporate formation has its trade-offs. These can include:
- Double Taxation (depending)
As previously discussed, there’s that whole double taxation thing. This can, in some cases, be avoided by filing as an S-corp instead of a C-corp.
- Lots of Red Tape
Along with the formality of the “Corporate” label comes the formalities of operations. In addition to all the upfront filing paperwork, these obligations include filing annual reports with the state, abiding by strict record-keeping mandates, conducting annual shareholder meetings, and maintaining a team of shareholders, directors, officers, and employees.
- Fluidity of Ownership
You’re not seeing double; fluidity of ownership can be a double-edged sword in corporations. When many shares are distributed across hundreds of shareholders and ownership is not invested in the organization’s success aside from financial gain, this can also mean turnover of governance, management, and a lack of united, mission-driven work. The result can mean discordance with the founding vision.
Choosing a business formation is influenced by a number of factors, including how risky a business is, the number of shareholders, operations, growth potential, and more. Do your research, consider your options, and if it comes down to it, tap into legal resources to get the job done right. So much goes into starting a business, but once you decide whether or not to go corporate, some of the dirty work and paperwork is in the rearview mirror.