Incorporating in the US - A Beginner's Guide

You're considering launching a business or have already initiated one, and now you're looking to formalise it by incorporating. Before taking this significant step, it's crucial to understand all the details and implications of incorporation. Here's a comprehensive guide to everything you should consider before making this pivotal decision.

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What is a "corporation"?

Fundamentally, a corporation is an independent legal entity distinct from its owners.

Legal experts often describe corporations as legal "persons." This means that a corporation is not just an extension of an individual; it exists as its own entity. This distinction is crucial primarily because it grants them a decisive advantage known as limited liability or liability protection.

A limited liability structure ensures that the personal assets of a corporation's owners are safeguarded from business debts. In essence, if a corporation incurs debt and then loses its assets, the lenders cannot pursue the personal assets of its shareholders.

When you invest in a corporation, for instance, by purchasing $2,000 in stock, your financial risk is limited to that investment amount ($2,000) and nothing beyond that.

Why is incorporating a good idea?

The primary reason for forming a corporation is often the benefit of limited liability, but there are several other advantages.

It legitimises the business

In cases where your business has multiple owners, the process of incorporation allows each party to assess the business and clarify roles and responsibilities.

A key decision in incorporation is determining the equity division – deciding the percentage of business ownership each partner will hold. Suppose you believe you're contributing the most effort to your business. In that case, the incorporation phase is an opportune time to discuss this with your co-founders and agree on an equity distribution that reflects your contributions.

It may reduce your tax liability

C-Corporations are treated as separate tax entities and typically taxed at a distinct corporate rate, which can differ from (and often lower) personal tax rates. This is particularly true following the Trump Tax Reform.

It facilitates investment

Incorporation simplifies the process for others to invest in your business. It enables the issuance of stock, allowing the company to have shareholders. Investors are generally more inclined to invest when they receive stock certificates in return, as opposed to informal agreements.

It enhances your business image

Incorporation also conveys to investors, employees, and the public that your business is established and serious about growth. It's more appealing to conduct business and sign contracts with a formal corporation than with an informal entity, like an individual using a personal email address.

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What types of corporations can you establish?

Typically, small businesses opt for two main types of corporations: C corporations and Limited Liability Companies (LLCs).

C corporations

The default form for corporations is the C corporation. Suppose you have filed and received approval for a certificate of incorporation from your state and have yet to convert your business into an LLC or S corporation. In that case, it is likely a C corporation.

C corporations consist of shareholders who own the company's shares, board members who guide the company's direction on behalf of shareholders, and officers who handle daily operations (like the CEO and CFO).

C-corps are taxed separately from their owners at a specific corporate tax rate. The IRS website is useful for detailed information on C corporation taxes.

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Limited Liability Companies (LLCs)

An LLC, which stands for Limited Liability Company or Corporation, acts like a corporation at the state level but is taxed like a partnership or sole proprietorship at the federal level.

Unlike C corporations, LLCs are not subject to corporate income tax. They avoid double taxation, meaning they are not taxed on earned income and, again, on distributed profits to owners. Instead, profits or losses pass through to the owners and are taxed only once.

The structure of LLCs differs from C corporations. LLCs have members who own and manage the business rather than having shareholders, board members, and officers.

The regulations for LLCs vary by state since they are state-level entities. Most states do not stipulate a minimum or maximum number of members for an LLC. This means an LLC can have just one member, like a local veterinary office, or thousands, as in the case of Google LLC.

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What is an S corporation?

An S corporation, formally known as a "Subchapter S corporation" or informally as a "Small Business Corporation," is a tax classification provided by the Internal Revenue Service (IRS). This designation allows corporations to pass their income, credits, and deductions directly to their shareholders.

S corporations themselves do not pay income taxes. Instead, the corporation's income or losses are divided among its individual shareholders, who then report this income or loss on their personal tax returns.

It's important to note that "S corporation" refers to a tax status, not a specific type of business entity. You can't initially incorporate as an S corporation. Instead, it would help if you first established a C corporation and then applied to the IRS to be recognised as an S corporation.

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How do you establish a corporation?

Before embarking on the process of forming a corporation, consider these key points:

1. Allow ample time, as the process typically takes several weeks.
2. Be prepared to use mail or fax for some steps.
3. Consult a specialised lawyer in small business incorporation before proceeding.

Step 1: Choose your corporation type

Decide between forming a C corporation or an LLC based on your business needs. This decision should be made with legal advice, as each type has different implications for growth and tax liabilities.

For information on establishing an LLC, refer to our specific guide. Continue reading for a detailed guide on forming a C corp.

Step 2: Select a state for incorporation

Choose a state with corporate regulations that suit your business. Delaware is popular due to its flexible corporate laws and business-friendly environment. Research your state's incorporation rules, tax rates, and industry trends, and consult a lawyer to find the best fit.

Step 3: Choose a name

Ensure your corporation's name is unique in your chosen state using the state's business registry. Also, check for any restricted words in your state and consider a Doing Business As (DBA) if you plan to operate under a different name.

Step 4: File articles of incorporation

Submit your company's articles of incorporation detailing the business name, member names, and address. This varies by state, so check your state government's website for filing locations and fees, which can range from $100 to $800.

Step 5: Adopt bylaws

Create bylaws outlining rules on ownership, responsibilities, shareholder rights, fiscal year-end, tax responsibilities, profit distribution, and contingency plans. Seek professional help for this step.

Step 6: Elect a board of directors

Your bylaws will define the board of directors' size, responsible for governing the corporation and making critical decisions.

Step 7: Issue shares

The board of directors will decide the distribution of shares, representing ownership stakes in the company.

Step 8: Appoint officers

Officers manage day-to-day operations. In smaller corporations, directors often also serve as officers.

Step 9: Obtain licenses and permits

Acquire your corporation's necessary licenses and permits based on state and industry requirements.

Step 10: Obtain an Employer Identification Number (EIN) from the IRS

Apply for an EIN for tax purposes via Form SS-4 or the IRS website. If opting for S corp tax status, file Form 8832 or Form 2553 as advised by a professional.

Step 11: Register for payroll taxes

Sign up for payroll tax payments with the IRS by phone or online, and set up an Electronic Federal Tax Payment System account.

Step 12: Register with Social Security Business Services Online (SS BSO)

Complete this step for Federal W2 filings, available on the Social Security Administration's website.

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Thinking About Incorporating? Here's What to Consider

Incorporation isn't a one-size-fits-all solution. For businesses that are more like a hobby, not chasing investors, or not too keen on a formal structure, diving into incorporation could be more trouble than it's worth.

Here's a friendly heads-up:

Incorporation Can Be Pricey

Setting up and running a C corporation is different from pocket change. It's pricier than kicking off a sole proprietorship (which you're doing anyway if you're in business) or starting a partnership with just a handshake. Brace yourself, especially if you're getting legal help (which is a smart move), as you might be looking at a bill in the thousands.

Get Ready for Red Tape and Lots of Paper

If paperwork isn't your thing, think twice. C corporations come with a laundry list of rules at every government level. Choosing to incorporate means signing up for a lot of paperwork and keeping a separate set of books for taxes and finances, which could eat into your Netflix time.

Watch Out for Taxes

Sometimes, incorporation means you're signing up for a heftier tax bill. Unlike personal taxes, corporations don't get the same breaks, and if your business hits a rough patch, those losses can't trim down your private tax bill. They get rolled over to the next year instead.

If you're set on incorporating, circle those tax deadlines in red on your calendar – missing them is a no-no.

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