How to Incorporate a Business

How to Incorporate a Business

How to Incorporate a Business

Incorporating your business or forming a separate business entity can provide significant legal and financial advantages. Corporations may provide entrepreneurs with valuable tax advantages. You can also build business credit and apply for financing in the name of your business, rather than personally. 

Learn about your options for incorporating your business. 

What is a Corporation?

The root of the word corporation is the Latin word corpus, or body. In the eyes of the law, a corporation is a person. This person stands independent from the people who formed it and make it run. It can sue someone, buy a car, sell a product, set up contracts, and pay taxes. 

Most businesses in the US operate as sole proprietors, which means they have no legal business structure. They may create a business name and get business licenses, but there is no legal separation between the business and the owner’s personal finances. 

For business owners, the main advantage of a corporation over a sole proprietorship is that the corporation itself is liable for its actions, rather than having the responsibility falling on the individual officers. Additionally, corporations can enjoy unlimited life — the existence of the company doesn’t depend on the presence of any one person or group of people.

Common Corporate Structures

The two main corporate structures are the C Corporation and S Corporation. An LLC, or Limited Liability Company, is another type of legal entity recognized by state law but it’s technically not a corporation. (To further confuse things, LLCs may elect to be taxed as corporations!) 

Each business structure comes with advantages and disadvantages, but all have the central advantage of helping to ensure that individuals are not personally responsible for business debts and obligations. That generally means personal assets are protected if the business is sued, provided the business entity is properly formed and maintained. 

Let’s take a closer look at each type of business structure individually.

C Corporation

A C corporation is the corporate structure most commonly preferred by business owners seeking investors. Investors contribute money and goods to a company in exchange for shares of stock in the company. The legal structure of a C corporation consists of a board of directors, officers, and shareholders who are required to hold annual meetings and record minutes. In addition, the rules for C corps are generally consistent from state to state. This combination of predictability and close accountability is attractive to those seeking to minimize risk when investing capital.

One of the biggest disadvantages of a C corporation is that its profits are taxed twice. This is called double taxation — the profits of the corporation are taxed once as corporate income when earned by the corporation itself, and again when distributed as shareholders’ dividends.

Pros and Cons of a C Corporation

S Corporation

An S corporation enables a small business or family business to enjoy the protections of a C corporation without having to pay the corporate taxes required of a larger company. Thanks to what is known as pass-through taxation, the owners of S corporations report their share of profit and loss on their individual tax returns. This usually means a lower tax rate on company profits.

Owners who are employees must take a reasonable salary but they may also get distributions (or “owner’s draw”). While the salary will be subject to payroll taxes, the distributions will not, and that may provide tax savings. However, the IRS may scrutinize both payroll and distributions, and could potentially recharacterize either, resulting in a tax liability or penalty. 

Pros And Cons Of An S Corporation

Limited Liability Company (LLC)

An LLC is one of the most popular entity structures for new businesses. It offers the asset protection of a large corporation but with a lot more simplicity. Owners are called members, and there is no limit on the number of members an LLC can have. They don’t have to be U.S. citizens or permanent residents, either. 

The LLC can either allow business revenues and expenses to pass through to owners’ personal income tax returns as it would if they were a sole proprietor (one member) or partnership (multiple members). Alternatively the LLC can elect to be taxed as a corporation. There’s also flexibility in terms of how profits are shared or distributed. 

Pros And Cons Of A LLC

What Is The Best Way To Incorporate A Small Business

To incorporate your business, you’ll need to determine which state you want to incorporate in; that may or may not be your home state. Then you need to file the required paperwork with the state agency, which may be the Department of Corporations, Secretary of State, or something similar.

If you want to create a corporation yourself, you can get in touch with the state office in charge of registering corporations in that state. It will provide information about the necessary forms and fees. Forming a corporation is more involved that starting an LLC, however, so if you decide to incorporate you may want to work with a professional. 

A business formation service or attorney can help you set up your corporation, usually for a reasonable fee. State filing fees will be an additional cost, and there may be fees for requesting an Employer Identification Number (you can request an EIN for free on the IRS website if you choose) or for additional services such as registered agent services.

What Is Required To Incorporate A Business

Though the procedure may vary slightly by state, generally to form a corporation, you must:

  • Choose a corporate name for the business
  • Decide which state to incorporate in
  • Get a registered agent to accept service of process
  • Prepare and file Articles of Incorporation or Certificate of Incorporation with the state authority
  • Pay filing fees
  • Create corporate bylaws
  • Get a Taxpayer Identification Number
  • Hold a meeting of the stockholders
  • Issue stock

These steps aren’t terribly difficult but they can be confusing and if you miss important steps, it could create problems down the road. 

You’ve Incorporated Your Business. Now What?

Your main job after incorporating—aside, of course, from keeping up with the strenuous demands of running a business—is to follow the rules. These are called “corporate formalities” and include things like keeping accurate records, holding annual meetings, and getting professional advice when needed. Fail to follow those and you may not have the personal liability protection you expected. 

In addition there are other tasks you’ll need to be sure to take care of:

These steps together will help you build a solid business foundation that can help your business qualify for small business loans and other types of financing in the future. 

This article was originally written on December 2, 2015 and updated on August 10, 2022.

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