If you own your own business, or are planning to start one, you should consider forming a corporation.  A corporation is a legal entity that exists separately from its owners.  Creation of a California corporation occurs when properly completed Articles of Incorporation are filed with the Secretary of State, along with the filing fee of $100.  Also, a Statement of Information form must be filed with the Secretary of State within 90 days after articles are filed.  After formation, directors must be elected, officers must be appointed, bylaws must be prepared and adopted, and shares of stock must be issued, all of which (plus other organizational matters) should be reflected in organizational minutes.

     The organizational structure of a corporation consists of three basic groups: shareholders, directors, and officers.  A corporation is owned by shareholders; however, they do not directly manage the corporation.  Instead, they influence corporate decisions through indirect methods such as electing and removing directors, approving or disapproving amendments to the articles of incorporation and voting on major corporate issues.  The directors, who comprise the “board of directors,” are responsible for managing the affairs of the corporation.  Usually, directors make only the major business decisions and supervise and appoint the officers who make the day-to day business decisions of the corporation.  Officers (e.g., President, Secretary and Treasurer) are agents of the corporation and are responsible for the everyday management of the corporation.

     Advantages of incorporating your business include:

          Limited Liability – Shareholders are not liable for the debts and obligations of the corporation.  However, shareholders may be liable (1) to the extent they personally guarantee corporate debts; (2) to the extent they receive improper distributions; (3) if a court “pierces the corporate veil” to impose personal liability on shareholders; or (4) if a controlling shareholder breaches a duty to the other shareholders of the corporation.  Maintaining the limited liability of a corporation requires that the shareholders and directors follow all the rules of governance, including holding annual meetings and maintaining meeting minutes.

          Tax Advantages – Corporations often gain tax advantages such as: the deductibility of health insurance premiums paid on behalf of an owner-employee; savings on self-employment taxes, as corporate income is not subject to Social Security, Workers Compensation and Medicare taxes; and the deductibility of other expenses such as life insurance.  For information on the types of tax advantages your business may gain by forming as a corporation, you should consult an accountant or tax advisor.

          Establishing Credibility – Incorporating may help a new business establish credibility with potential customers, employees, vendors and partners.

          Unlimited Life – A corporation has an independent existence and is not terminated by the withdrawal, death or other event affecting its shareholders, directors or officers.

          Transferability of Ownership – Shares of corporate stock are generally more easily transferred than partnership or LLC interests.  There are generally no statutory limits on the right of a shareholder to transfer stock, and the consent of other shareholders to the transfer is not required.  However, in closely held corporations, the transfer or other disposition of shares is often restricted by a shareholders’ agreement or by provisions in the articles or bylaws.

          Ability to Raise Capital – Capital can be raised more easily through the sale of stock.  Additionally, many banks, when providing a small business loan, want the borrower to be an incorporated business.

          Retirement Plans – Retirement funds and qualified retirement plans, such as a 401(k), may be established more easily with a corporation.

     Disadvantages of incorporating include:

          Taxation – The primary disadvantage to a corporation is double taxation.  Profits of a corporation are taxed first as income to the corporation, then as income to the shareholder when paid as dividends.  However, all reasonable business expenses such as salaries are deductions against corporate income and can minimize the double tax.  Furthermore, the double tax can be eliminated by making an “S” corporation election.  An S corporation is simply a regular (“C”) corporation that files IRS form 2553 to elect special tax status with the IRS.  The S corporation is a pass-through tax entity, which means that the income or loss generated by the business is reflected on the personal income tax return of the shareholders.  Also, a California corporation must pay a minimum franchise tax of $800 per year.

          Formalities – There is generally more complexity and expense with forming a corporation, and there are more extensive record keeping requirements.  However, having good legal counsel can minimize the amount of your own time and energy spent in complying with the legal procedures.

     If the advantages of forming a corporation are beneficial for your business, we would be happy to take care of your incorporation.  Please call for a free consultation today!

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