A corporation is a type of business structure and legal entity that is declared separate from its owners and shareholders. Corporations enjoy similar rights to a person, such as entering into contracts, owning assets, loaning money and hiring. It has these capabilities without the risk of being personally liable for business debts or legal obligations (in most cases).
In this article, we’ll discuss how to form a corporation, the costs involved, and the main advantages and disadvantages to help you decide if it’s the right business structure for you.
How To Form A Corporation
Corporations can be the most expensive and difficult business structure to form. This is why we recommend hiring a lawyer or using an online legal service to help you customize corporate documents. In most states, you will need to do the following to form a corporation:
- File articles of incorporation
- Create organizational resolutions that specify the operating rules for the corporation
- Appoint board of directors
- Issue stock certificates to your initial shareholders (this last step can be complicated because stock certificates must comply with federal securities laws).
Some lawyers recommend having a founders’ agreement which is similar to a partnership agreement to prevent disputes among business owners. In addition, you must register a trade name (if applicable) and obtain local permits as you would need to do with any business form.
Corporations require a lot of paperwork and requirements. They must hold annual board meetings and shareholder meetings where most decisions in running the corporation must be made by a formal vote and documented in meeting minutes. Businesses should keep other documents as well such as stock ledgers, at their business location. In addition, mostly all states require corporations to submit an annual report.
Costs to Form a Corporation
Incorporating a business comes with certain fees. Depending on which state a corporation is formed, businesses can expect to pay around $100 – $700 when establishing a business and around $10-$350 when filing their annual report. Below are some examples of states and their corresponding incorporating and annual report fees:
Tax Obligations of Corporations
Corporations are not as tax friendly as sole proprietorships and partnerships. In fact, a frequent complaint about corporations is that you are subject to “double taxation.”
Income from your corporation is first taxed at the current corporate tax rate of up to 35% (see current corporate tax rates). Income that is paid out to owners in the form of salary is then taxed again at the recipient’s personal income tax rate. Income that is paid out as dividends to shareholders is also taxed at the current dividend rate (15% for most taxpayers).
If you want to avoid double taxation, you can make an S Corp election when filing taxes. As an S Corp, the profits from the business pass through to the individual owner’s tax returns and there is no need to file a corporate tax return. However, to be eligible as an S Corp, you must have no more than 100 shareholders and have only one class of stock.
Advantages of Forming a Corporation
1. Limited personal liability.
One of the biggest advantages of running a corporation is that you cannot be held personally liable for business debts or legal obligations. The corporation is an entity separate from its owners and can be sued apart from its owners. However, in cases of misconduct or negligence (e.g. fraudulent financial activity), the court will “pierce the corporate veil” and hold owners, members, or shareholders of a corporation personally liable for the company’s legal obligations.
Also, if you personally guarantee a loan that’s taken out on behalf of the corporation, and you default on the loan, creditors can come after your personal assets to satisfy the loan.
2. Easy to raise capital and unlimited growth potential.
Corporations are seen as established entities and have a greater chance of attracting investors and raising business capital. Additionally, corporations offer unlimited growth potential through its sale of stocks.
3. Stability in business existence.
Corporations can continue to exist even if the owner leaves the company, unlike other business structures such as sole proprietorship and partnerships that are closely tied to their owners. Shareholders can also easily share their stocks and the corporation can continue doing business without disruptions in operations.
Disadvantages of Forming a Corporation
1. Possibility of double taxation.
Corporations can be taxed twice. First, when the business earns income. Second, anytime it offers a dividend, shareholders get taxed with the amount that they receive in their income tax returns. If you are eligible, you may want to use S Corp as your business structure instead to avoid this.
2. Extensive paperwork and requirements.
Corporations need a lot of paperwork and requirements such as articles of incorporation and bylaws before it is established. It is also required to establish operational formalities and organize internal affairs such as appointing board of directors and holding regular shareholders’ meetings.
Additionally, if a corporation does business in one state and wishes to expand to a new one, it must observe due diligence to meet the requirements of the other state before it can operate.
3. Limited business structure flexibility.
Because of all the formalities that corporations must adhere to, they are not very flexible. Most management decisions must be approved by the board in a formal meeting. Even closing down a corporation requires a formal vote, and dissolution forms and/or tax clearances must be filed with the state. A one-person corporation is more flexible since one person serves as officer, shareholder, and director.
If you are planning to establish a corporation, we hope that this article helped. Remember, corporations are ideal for more established businesses and takes more complicated steps to form compared to other business structures. We encourage you to get legal counsel before deciding on using a corporation as your business structure.
To learn more about how to setup a business, read our article on the best business structure.