You have a great idea for a business, and you have spent countless hours crafting your business plan. Is it now time to incorporate your idea? It depends.
A corporation is a separate legal unit from its owners. It exists once it has a unique name, incorporation paperwork is filed, and fees are paid. A corporation is comprised of three groups: officers, who manage the daily operations; directors, who oversee the overall operations and appoint officers; and shareholders, who own the company's stock and vote on various issues — they elect the board of directors, for example. A corporation can consist of one person, who holds all three roles, or many people.
Why incorporate?
Because a corporation is legally distinct from its shareholders, it presents multiple benefits:
- Limited liability — a corporation's shareholders are not liable for a corporation's actions and their personal assets cannot be used to pay the company's debts.
- Unlimited life — corporations can be sold or easily transferred and exist even though their owners may not.
- Stock issuance — shares of stock can be issued only by a corporation; this feature can be useful in attracting investors and raising capital.
- Tax benefits — employee benefits are tax deductible, and profits can often be taxed at a low corporate rate.
Why not incorporate?
Despite the benefits, incorporation isn't for every business. In some cases, the cost and complexity of filling out paperwork and maintaining corporate files outweigh the tax and legal advantages. Also, a corporation must pay taxes when it distributes its profits to its shareholders — this is in addition to the taxes it pays on its profits. Because of these reasons, many small companies choose other business forms, such as S corporations, partnerships, or LLCs.
S Corporation
A company choosing to become an S corporation is not taxed as a separate legal entity, even though it is a form of a corporation. Instead, such a corporation has made an election with the IRS that allows its shareholders to report profit or loss on their individual tax returns, rather than the corporation's return. Companies with fewer than 75 shareholders may choose to qualify under subchapter S of the IRS code and take advantage of this alternate form of tax reporting.
Partnerships
For some companies, partnerships work best. This arrangement allows profits to be passed through to shareholders and not taxed at the corporate rate. However, partnerships do not allow for the issuance of stock, nor can a partnership shield the owner from liability in the way a corporation does.
LLC
An LLC is not considered a separate legal entity from its owners as is a corporation, but it operates more informally than a corporation since there are fewer requirements and restrictions on its operations. LLCs combine the limited liability benefits of a corporation with the tax benefits of a partnership. In most states, one person can start an LLC. The profits of an LLC are taxed on the owner's income tax.
How to incorporate or form an LLC
- Location, location, location. Incorporation is managed on the state level. You can pick any of the 50 states or the District of Columbia in which to incorporate, whether you're a resident of the state or not. However, it is usually best to incorporate in the state where your headquarters are, or where you'll be doing business. Remember: if you do business in a state other than the one in which you've incorporated, you'll have to register there as a foreign corporation and pay the related fees.
- So many choices. Choose your business name, and check with your state or your attorney to make sure that the name has not already been taken. The name you choose must indicate what type of entity you are forming — most states require that Incorporation, Corporation, Limited Liability Company, or an abbreviated form of those words follow your company's name.
- Let the paperwork begin. File articles of incorporation (sometimes called different names depending on the state), a legal document that lists your company name, address, business purpose, and names of your board of directors, with the appropriate registering agency. The secretary of state oversees and registers corporations in most states, although in some states it is the department of revenue or the corporation commission that manages this function. See the attached chart for contact information for the appropriate agency in your state.
- Let the payment begin. Pay the related filing fees, which vary by state. The minimum ranges are between $35 and $300 for a profit corporation, between $8 and $200 for a non–profit corporation, and between $35 and $500 for a limited liability company. It is often wise to hire a lawyer who has experience with the corporate law of the state in which you are incorporating. Figure on a minimum of $1,000 for the lawyer and the filing fees. Once incorporated, you don't need to renew your incorporation each year, but you should check with your state registering agency for information on making amendments to your articles of incorporation and filing annual reports.
For more information, including rates and contact information by state, click here.
Go online
Online sources can guide you through the incorporation process. First check with your state's government Web site to review the requirements for incorporating. Almost all states provide instructions, fees, and downloadable forms online. For example, Rhode Island's Secretary of State Web site includes downloadable forms, fees, and an online, searchable database of corporations that can be useful when deciding on a name. The site also presents weekly listings of new incorporations. The Arkansas Secretary of State Web site allows business owners to incorporate by filling out forms from their desktops and submitting them online for an additional $5.00 processing fee.
