Creating a corporation: Your step-by-step guide
Starting a corporation differs considerably from launching a sole proprietorship, partnership, or limited liability company (LLC). Specific advantages and limitations apply to corporations. If you want to start doing business as a corporation, you’ll need to understand the details, and this article will help you do just that.
- Different types of corporations (C, S, or B) will function differently, particularly in taxation.
- Creating a corporation requires you to meet state-specific requirements.
- A professional service may remove the guesswork and help you register your business faster and with more confidence.
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What is a corporation?
In the broadest definition, a corporation is a legal and IRS-recognized business structure that functions as a separate legal entity from its business owners.
Corporations offer limited liability protection, meaning shareholders may see their ownership shares appreciate and receive dividends, but they usually aren’t liable for debt the company accrues.
For-profit corporations have the option to be publicly traded or privately owned. Publicly traded companies typically have many shareholders, while private companies tend to have a small group of owners. There are three types of for-profit corporations: C Corp, S Corp, and B Corp.
A for-profit corporation isn’t the only option. Nonprofit corporations also exist, primarily in the form of charities. Nonprofit corporations are different in that they must have a stated charitable purpose. Additionally, profits are used to further the nonprofit’s mission; a nonprofit does not have shareholders who share in business profits. The corporation works toward its purpose whether it earns a profit or not.
The best way to explain the three types of for-profit corporations is by clarifying the letters C, S, and B. “C” and “S” refer to the U.S. tax code subchapters C and S, determining taxation for the two corporation types. The “B” in B corporation stands for “benefit.” The fourth type of corporation is Nonprofit.
A C Corp is the default type assigned automatically by the IRS when you form a for-profit corporation unless you specify otherwise. This type of corporation is subject to corporate income tax on the federal and state level. This means that the corporation itself is taxed separately from its owners.
An S Corp designation means there’s no corporate income tax for federal tax purposes. Instead, each shareholder pays federal income tax on their share of the corporation’s income based on the number of shares they hold. You must meet eligibility requirements and file IRS form 2553 to register as an S corporation. States vary in how they treat S Corps from a tax perspective.
A B Corp is a for-profit company with a mission of social contribution. B Corp Certification is a voluntary certification, awarded by the nonprofit B Lab, that validates a company’s commitment to social and environmental responsibility. This certification requires your corporation to provide regular reports to the appropriate authorities to keep track of your mission’s progress.
If you choose to seek B Corp status, the easiest time to do so is early in your business’s lifecycle. It’s important to know that a B Corp will also be a C Corp or S Corp, depending on your tax election (C or S Corp indicates the organization’s IRS tax status; B Corp is not a tax status).
Unlike C, S, and B Corps, which are for-profit, a nonprofit corporation’s purpose is not profit creation. Nonprofits exist for the benefit of the public or to support a specific cause, such as charitable, educational, or religious activities. Nonprofits with a charitable purpose may apply for tax-exempt status and must reinvest surplus funds back into the organization’s mission.
Starting a corporation may come with several benefits including the following:
In many cases, shareholders can reduce or even eliminate their personal responsibility for a corporation’s liabilities and/or debts. As a shareholder, you may protect your personal assets in many cases, even if the corporation falls into debt.
A for-profit corporation is owned by its shareholders. As a result, a corporation can easily change ownership through stock buying and selling. This means that the business doesn’t cease to exist if one or more owners or board members decide to leave the corporation or are replaced. Nonprofits will also continue to exist even as founders and board members come and go.
Access to funds
Selling stock is one way to raise funds in a corporate organization. Corporations can sell stocks to finance further growth and bring in new owners. C Corporations can issue multiple classes of ownership shares and have greater flexibility in who can participate.
Tax benefits (for S Corps)
S Corps have the potential to create more favorable tax outcomes for their owners. By taking an S Corp tax election, the corporation becomes eligible for special pass-through taxation status. An S Corp’s profits are not taxed at the corporate level, rather, owners pay tax on their individual tax returns. It’s worth noting that owners who perform services for the business must pay themselves a reasonable salary, which is subject to employment taxes.
Disadvantages of a corporation Business Structure
While a corporation may be beneficial for financial and tax purposes, this business model isn’t without its downsides including the following:
Starting your own business will always come at a cost, however, launching and maintaining a corporation is typically pricier than an LLC, partnership or sole proprietorship.
A sole proprietor may be shocked by the protocols and formalities a corporate entity must follow. Some of these include maintaining a board of directors, holding regular shareholder meetings (with written meeting minutes), filing annual reports, and strictly following its corporate bylaws. Further, it can be difficult and time consuming for a corporation to change its entity structure (i.e. converting to an LLC).
C Corp income is taxed twice; first the corporation pays taxes on its business profit, then shareholders pay individual taxes on dividends they receive. Taking an S Corp election can relieve owners of double taxation.
If you’re an entrepreneur looking to start a corporation, the following steps will typically get you there. Certain states have different requirements, so be sure to research which criteria apply to your state or hire a third party to help you meet all local requirements.
First, your business will need a corporate name. Business names follow certain conventions in all states, and those conventions may differ. Do your homework and ensure the chosen corporate name fits the requirements in your state of incorporation.
A unique, legally distinct company name is among the universal conventions. To find out if a name is available and not already registered, conduct a search with your Secretary of State’s office.
All corporations are required to have a board of directors to guide decision-making and represent shareholder interests. The mandatory number of board members varies by state. Some states allow your board of directors to consist of one person, while others mandate more members.
Your corporation may start with a temporary board of directors, which can change down the line.
Your corporation’s Articles of Incorporation is a document containing essential information about the business. Required information varies by state, but it will usually include your corporation’s name, address, and purpose. You’ll need to specify your registered agent, initial board members, and incorporators.
Filing the Articles of Incorporation is a prerequisite for getting your Certificate of Incorporation. The actual document filed differs from state to state and is usually subject to filing fees which typically range from $50-$300.
Corporate bylaws and shareholder agreements detail the rules of operation and the shareholders’ relationships with each other and the corporation. These documents define particular roles within the organization, decision-making processes, the time and place of annual meetings, and even bank accounts for dividend payments.
Depending on the state, these documents may be mandatory and require different specific information.
An employer identification number (EIN) is much like a Social Security number for businesses. The IRS requires corporations have an EIN. Luckily, you can easily apply for an EIN directly from the IRS using their website after your state incorporation is complete.
Launching your corporation
Once your corporation is formed, there are some additional formalities to complete to help ensure your business is set up for success.
Hold a board of directors meeting
An initial board of directors’ meeting is required to determine key operating and management practices for your corporation. For instance, the decisions made at this meeting typically include appointing company officers (like the CEO), approving corporate bylaws, and establishing the accounting year. If you only appointed temporary board members to complete the formation documents, a permanent board will also be appointed at this meeting.
Additional board meetings are required periodically (typically on an annual basis) and when there are substantial changes to your corporation as defined in your corporate bylaws.
Obtain business licenses and permits
Certain business licenses and permits may be required depending on your corporation’s industry, state of incorporation, or operating location. For example, businesses that manufacture or sell alcohol or tobacco typically require special permits. Depending on your state, you might need a general business license, regardless of the industry.
In most cases, you must obtain proper licenses and permits prior to beginning business activities or collecting revenue. It’s a good idea to research requirements for obtaining and maintaining proper licenses and permits in your state and/or municipality early in your business planning process.
Ownership of a corporation is defined by stock shares. By issuing stock, your business becomes owned by various shareholders who contribute to the company. The maximum number of shares is determined in your Articles of Incorporation.
This step of the process is subject to specific regulations. For instance, S Corps may only issue one type of stock and 100 or fewer allowable shareholders
Incorporating your business can be complex, but it doesn’t have to be. A professional service like Block Advisors Business Formation can help you incorporate. Getting started takes just 10 minutes, then you can get ready to change your title to CEO.
Navigating your options
Whatever route you choose, to create a corporation, stay a sole proprietor, or select another entity type, it’s important to consider your personal situation and needs of your business. Laws vary from state to state. This article is intended to be informative, but it is not legal advice or a substitute for legal advice. A business attorney can help you understand your specific circumstances and guide your decisions. Likewise, the Secretary of State’s office in most states offers resources for small business owners, including online information that may help owners to decide the best options – and possible requirements – for their specific circumstances.
We, at H&R Block and Block Advisors, look forward to continuing to support you throughout your business journey. We are committed to helping your business thrive and our Small Business Certified Tax Advisors are available year-round, virtually and in person, to help you keep more money in your pocket.
Launch your business today
Creating a corporation can be complex for people who’ve never done it before. Working with a professional service, like Block Advisors Business Formation, can take the filing process off of your plate so you can focus on launching and running your business.
The most significant advantages of forming a corporation relates to financial safety. As one of the corporation owners, you could have greater protection in terms of personal liability, business security, and capital access. Further, the business exists outside of its owners and managers (perpetuity) and it is easy to transfer ownership interests via stock. The disadvantages include more expenses, taxation, and a more rigid business structure.
A corporation is a separate legal entity from its owners, offering limited liability protection to shareholders, but still subject to double taxation. An LLC (Limited Liability Company) is also a separate legal entity that combines the liability protection of a corporation with the pass-through taxation of a partnership, where profits and losses “pass through” to the owners’ personal tax returns.
Additionally, corporations have more formalities and government requirements, while LLCs offer more flexibility in management structure and fewer compliance obligations.
C Corps and S Corps are taxed differently and have different ownership requirements. C Corps are subject to double taxation, this means profits are taxed at the corporate level and that money is taxed again when it is passed to shareholders as dividends. S Corps are pass-through entities. They avoid double taxation by passing profits and losses to shareholders’ personal tax returns. C Corps have few ownership restrictions and can have unlimited shareholders, while S Corps have limitations on the number and type of shareholders.
The advantages of starting a corporation include:
- Limited liability protection for owners
- Corporate tax deductions and credits
- The lifespan of the business is not tied to individual owners (perpetuity)
- Limitless ownership transfer, except with S Corporations
- Stock can be used to raise capital and distribute business ownership
C Corporations pay taxes on their profits independent of owner taxes and profits. This is because the business is viewed as a separate legal entity, including taxation. The money spent on business purposes, like salaries, advertising, and operating expenses, is tax-deductible. Corporations must file a business tax return with the IRS annually.
What does it mean to be a tax-exempt nonprofit corporation?
Not-for-profit corporations with a charitable purpose can keep all their earnings and/or charitable donations in the business by applying for 501(c)(3) tax exempt status. To be eligible for 501(c)(3) status, an organization must have an eligible charitable purpose and cannot participate in political/lobbying activities or have shareholders.
This article is for informational purposes only and should not be construed as legal advice. You may want to seek the advice of an attorney to evaluate all relevant considerations.
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