How Do You Incorporate a Business, and What Are the Benefits?

Incorporating a business creates a separate legal entity, protecting personal assets and offering potential tax advantages. This process enhances credibility, simplifies ownership transfer, and provides growth opportunities while requiring compliance with specific regulations.

By Brad Nakase, Attorney

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Table of Contents

1. Why should you incorporate a business?

2. Is forming a US corporation mandatory?

3. Benefits of forming a corporation in the USA

4. How to Incorporate a Company

Why should you incorporate a business?

A corporation in the state of California is a distinct legal entity that exists independently from its owners. Corporations are advantageous because they shield owners’ private wealth from corporate obligations. Owners’ private wealth is often immune from claims brought against corporations by creditors and litigants. But corporations face what is frequently called “double taxation.” When shareholders receive dividends or capital gains, they are taxed, and corporations are taxed when they make profits.

Both C and S corporations are legal forms of business organization. S corporations “carry through” their earnings to the owners’ individual tax returns, which helps them avoid double taxation, in contrast to the more conventional C corporations. For businesses that value control more than “going public,” a close corporation may be the best organizational structure. The number of shareholders in a close corporation, often called a “tightly held” business, is typically small, and the transfer of shares is generally limited. Family enterprises and other types of organizations benefit greatly from the use of close corporations.

Properly following all the processes of incorporation is crucial, regardless of the method a firm chooses to incorporate. Proper incorporation is essential for an organization to enjoy the benefits and protections offered by a corporate structure, including immunity from liability.

Businesses can get several market benefits by incorporating in the US. Any company, especially one aiming for expansion and financial rewards, might benefit from incorporating, since doing so provides a number of advantages, including more trust with stakeholders and legal safeguards.

A business’s personal assets can be better safeguarded when they incorporate, which also opens doors to development, scalability, and possible tax advantages. We will go over the benefits of incorporation for companies below.

When a company decides to incorporate, it is changing its legal status from that of a partnership or sole proprietorship to that of a corporation. To complete this step, you must gather the necessary paperwork and submit it to the appropriate state agency, usually the Secretary of State.

When a company becomes an LLC, it takes on the identity of its own legal entity. The corporation and its owners or managers are considered distinct entities for legal purposes. There are consequences for operations, taxes, and responsibility stemming from this difference.

A company must submit articles of incorporation as part of the paperwork and registration procedure. Name, address, and stock information of the corporation are among the basic elements included in this document.

The ownership structure of a corporation is based on the issuance of shares of stock. Companies that go public often have their shares traded on stock exchanges, although smaller companies may choose to distribute their shares to select individuals.

The activities and governance of a corporation are governed by a board of directors who are obligated to follow specific procedures for corporate governance. A chief executive officer (CEO), chief financial officer (CFO), and chief operating officer (COO) often run these organizations on a daily basis.

Because of their distinct legal status, companies are subject to a wide range of rules and regulations enacted at the federal, state, and regional levels. This usually means paying fees, completing annual reports, and other administrative tasks.

Concerning taxes, businesses are subject to several regulations. Dividends distributed to shareholders as well as the profits of the corporation itself may be subject to double taxation, which varies by jurisdiction and business form. On the other hand, they may be eligible for tax breaks that may not apply to sole proprietorships or partnerships.

Is forming a US corporation mandatory?

No, incorporating your company is not mandatory. A company’s decision to incorporate should be based on its own unique circumstances and objectives. Many companies get by just fine without ever becoming an official corporation, instead choosing to remain as partnerships or sole proprietorships. Nevertheless, as we will see later on, there are a lot of benefits that are exclusive to companies that have incorporated.

Benefits of forming a corporation in the USA

Businesses may get numerous benefits by incorporating in the US, including favorable tax treatment, a certain path to development, and easier access to top personnel. The benefits that encourage companies to form corporations are as follows:

1. Liability

Any individual thinking about going into business for themselves should give serious thought to the idea of personal liability. The line between the owner(s) and the business itself becomes more porous in unincorporated enterprises like partnerships and sole proprietorships. The owner’s or partner’s private life is vulnerable to the company’s financial or legal troubles because of this lack of separation.

To illustrate the point, let’s say a client sues an unincorporated company for monetary damages. The financial ramifications can be enormous regardless of the cause of the lawsuit—a product flaw, an operational mistake, or a disagreement over a contract, for example. Without the corporate veil, the owner’s life savings, real estate, and other assets are fair game for recovery. Similarly, creditors may try to get their hands on the owner’s personal assets if the company gets into a lot of debt that it can’t pay off.

The customer’s lawsuit would take a drastically different turn if the defendant was a corporation. By incorporating, a business establishes itself as a separate legal entity from its owners, managers, and stockholders. The “corporate veil” refers to the protective barrier that this separation provides. The assets of this distinct corporation are at stake in the event that any financial or legal complications emerge. Shareholders’ and directors’ private possessions and wealth are safe from such threats.

Having said that, this protection isn’t foolproof. It is possible to “pierce the corporate veil” and hold the people behind the business personally accountable in cases of fraud or specific forms of carelessness. However, this disclaimer aside, there is no denying the superior protection that incorporation provides over unincorporated structures. A strong argument in favor of incorporation, according to many company heads, is the decreased possibility of individual liability.

2. Tax benefits

One of the most important factors for companies to think about when assessing operational structures is taxes. Corporations and sole proprietorships are subject to different tax laws, and these discrepancies can be somewhat significant.

As a result of their status as independent legal entities, corporations have to adhere to a different set of tax requirements. Multiple possible advantages become available to them as a result of this distinction. The possibility of reduced tax rates is a major perk. Companies, particularly those with a lot of income, may save a ton of money on taxes since corporate income tax rates are often lower than individual income tax rates, though this varies by jurisdiction and other factors.

Businesses also gain a lot from being able to carry forward losses. If a company loses money one year, it might use that money toward making more money the next year. This provision can help businesses, especially startups or ones going through a tough patch, by letting them offset the losses from bad years with the gains from good ones when it comes to taxes.

Another potential advantage for companies is deductions. All companies can take advantage of some deductions, but corporations often have access to more deductions overall or to a larger pool of them. Such deductions can significantly lower a company’s taxable income and cover a wide range of business expenses, from employee perks to operational expenditures.

In contrast, for tax reasons, owners of partnerships or sole proprietorships often combine their personal and company money. The owners’ or partners’ individual tax returns get the full amount of the business’s gain or loss. Although this structure is straightforward, it does not provide the flexibility that companies have when it comes to tax strategies.

In addition, corporations are occasionally eligible for certain tax advantages that are unavailable to unincorporated businesses. A wide variety of endeavors, from R&D to environmental projects, may qualify for these credits, which immediately lower the amount of tax that must be paid.

Corporations need to be more careful with their records and report more frequently if they want to take advantage of these tax breaks. But if it’s done right, the possible tax rewards can be much greater than the management costs.

3. Transferability and permanence

An often-overlooked benefit of incorporating is the idea of permanence. If you form a corporation, your company may continue to exist after you and your investors have passed away. This consistency provides a level of security that may be more challenging to attain with alternative company models.

The transfer of ownership of a company does not interfere with the regular running of the business. If the owner of a successful organization with hundreds of workers and current contracts wants to retire or try something else, all they have to do is sell their shares to someone else. Shareholders may notice the change, but partners, workers, and consumers won’t notice a thing.

When one partner leaves a partnership or sole proprietorship, it may be necessary to renegotiate contracts, reestablish ties, and even restructure the business model. For clients and consumers who have been around for a while, this might cause confusion and put their long-term relationships at risk.

Furthermore, selling shares in a company is a standard procedure that is known and accepted all around the world. Many legal frameworks, stock exchanges, and brokers exist to make this possible. Ownership transfers involving partnerships or single proprietorships typically necessitate expensive and time-consuming tailored agreements.

Two of the most important reasons why investors choose to work with corporations are the simplicity of ownership transfer and the permanence of the investment. Venture capitalists and angel investors, who want to recoup their initial investments through the sale of shares in a later period, find corporations appealing because of the obvious exit route they provide.

4. Growth and credibility

When a company incorporates, it gains more legitimacy and respect from the people it serves. Incorporation shows the outside world that a company is serious about being in business for the long haul and has taken the required steps to establish its credibility.

An unincorporated entity may not be as trustworthy as a corporation, in the eyes of the consumer. To hold companies more responsible for their goods and services, for example, there are stricter reporting requirements.

Companies may also attract suppliers who are interested in forming long-term partnerships or contracts. Corporations are less prone to sudden shifts in direction because of their rigid organizational structures. This may cause people to be more amenable to negotiating or lead to better terms overall.

When it comes to deciding how to devote their capital, investors frequently opt to put their money into corporations. This is due to the fact that forming a corporation shows a dedication to long-term success, and that investors may feel more comfortable with the investment due to the more transparent procedures for shareholder rights and protections that corporations provide.

Incorporation is frequently an absolute must for companies planning significant expansion, such as those looking to attract large-scale investment from outside sources or contemplating an IPO. Corporate status is required by external investors or capital markets in order to provide the shareholder protections, governance frameworks, and transparency that are inherent to the status.

5. Obtaining funding

Corporations are in a good position when it comes to obtaining financing because of their structural advantages. The capacity to provide stock is one of these benefits. A business gives investors a stake in the company when it sells shares. These individuals or groups give the company the money it needs by purchasing shares in the hopes of receiving dividends or seeing their value rise.

Companies also have the option of issuing bonds. Bonds are effectively loans from investors to the firm, as opposed to shares, which give a piece of ownership. After a certain length of time has passed, the corporation promises to repay the bond’s principal plus interest at regular intervals. Businesses can use this process to raise a lot of money without having to give up any of their ownership stake.

These sources of funding are important. Corporations may ramp up their R&D spending, take on more daring initiatives, buy other companies, and enter new markets with greater resources. These steps can help the company develop, which is good for the shareholders’ bottom line and the company’s future growth prospects.

6. Transfer of ownership

An advantage of a corporation’s form is that it facilitates the transfer of ownership. Possessing tradable ownership shares makes the whole thing more clear and easier to handle. This is in stark contrast to the difficulties encountered by partnerships and sole proprietorships when trying to implement the same change.

The very nature of shares makes them a flexible form of ownership. One way for individuals to invest in a company is by purchasing shares, which allow them to have a proportionate ownership in the business. Shares can allow varying degrees of investment, from a substantial stake to a fractional interest, without requiring a reorganization of the company’s fundamental activities or a renegotiation of its basic agreements.

This flexible concept is not applicable to partnerships and sole proprietorships. When you sell your business, you may have to renegotiate some of your contractual duties as well as look into the fine print of your agreements, assets, and liabilities. It may take a long time and be quite complicated.

Corporations also have a strong legal structure that backs their share-based system. There are well-defined procedures for selling shares, the rights they grant, and the resolution of any issues that may arise in connection with them. Less formalized business forms, such as sole proprietorships and partnerships, lack this clarity and can lead to muddled conflict resolution.

Also, corporate shares, particularly those of publicly listed corporations, have the attractive liquidity feature. Owners benefit from a degree of liquidity that is difficult to achieve in other types of company structures because to the rapid buying and selling of shares on stock markets.

7. Separate credit rating

It is possible for a corporation to create and maintain its own credit rating independent of its owners. In situations requiring financial borrowing or the establishment of credit connections, their unique financial identity may be a benefit and serve numerous functions.

Because of this legal distinction, the creditworthiness of the business is unrelated to the owners’ personal spending habits and credit scores. For instance, when the company tries to get financing, it won’t care whether the owner has a history of financial problems or personal difficulties. The company’s payment history, debt levels, and management of its finances are the key indicators of its creditworthiness.

Better financing conditions are possible when a company has a high credit rating. Companies with established track records of timely payments typically get preferential treatment from lending institutions. Loans of greater amounts or with more favorable interest rates may be more readily available to corporations than to individuals or unincorporated business entities with lower credit ratings. These advantageous conditions can lead to significant savings and financial advantages for the company in the long run.

Having a distinct credit rating might also offer owners an extra degree of security. As long as the owners keep to the formalities of a company and don’t put their personal credit on the line, their personal credit scores will be safe from any financial difficulties or loan defaults that the business faced. By keeping their own money separate from their company’s, owners may rest easy and take more measured risks, both of which are good for the company’s success.

Keeping a separate business credit rating might also help with vendor and supplier relationships. Having a solid corporate credit rating may result in better terms, including longer payment periods or discounts, which can increase operational efficiency and profitability. This is because many suppliers examine a corporation’s creditworthiness before extending terms or creating long-term contracts.

8. Employee benefits

Stock options and other corporate perks are a powerful motivator for both existing and potential workers. When vying for top-tier talent in highly competitive sectors, this competence is crucial to many firms’ recruiting and retention strategies.

A stock option gives an employee the legal right to buy a certain amount of stock from the business at a certain price. Workers will be able to cash out their shares when the stock price of the firm reaches or exceeds this target. With this system in place, workers’ goals may be more closely tied to the company’s bottom line. If the business does well, the people who have stock options and the stockholders will both reap the rewards. Stock options can be a deciding factor for prospective workers, particularly those with specialized talents or senior-level positions.

Employees may be more likely to stay put if they have stock options. Stock options often include a vesting schedule that stipulates an employee must stay with the company for a specific amount of time before they are able to cash in all of their options. This decreases the probability of turnover while also encouraging long-term commitment. Less employee turnover means better institutional knowledge and team cohesiveness, which in turn means less recruiting expenses.

How to Incorporate a Company

Naming Your Business

As long as it stands out and doesn’t mislead others, a California incorporator can name their company practically anything.

The name of a company is considered distinguishable in the state of California if it contains at least one different letter or number or another arrangement of the same letters or numbers that is clearly recognizable by sight.” This does not include capitalized or lowercase letters or characters, font, or punctuation. There is no discernible difference between A.P.E.X. Incorporated and Apex Corporation, for instance.

The Commissioner of Business Oversight must approve any name changes that might lead the public astray, such as those including “bank” or “trust,” and the name cannot resemble any government agency, such as the “CIA” or the “State Department.”

Close Corporations

According to California law, a “close corporation” is defined as a business entity in which the number of stockholders is 35 or less. The words “corporation,” “incorporated,” “limited,” or any combination thereof must be present in the name of a California close corporation.

You can pay the Secretary of State to reserve a name for your corporation. The reservation can only be extended once per 60 days. You should probably see if the domain name is for sale as well. An organization must submit a DBA (Doing Business As) form if it does business under a name different from its legal name. One more thing: a registered name isn’t the same as a trademark. You can register a trademark with the state trademark office or the U.S. Patent and Trademark Office.

Picking a Registered Agent

On behalf of their company, registered agents accept service of process, letters from government agencies, and compliance paperwork. Individuals or entities can serve as registered agents, however corporations cannot act as their own registered agents when service of process is required. Nevertheless, an officer or director may act as an agent. An agent service is something that certain companies, particularly bigger ones, like to use. Whatever the case may be, the following are the requirements that a registered agent in California must fulfill:

Must be 18 or older
Has a California physical address
Is reachable in person throughout regular office hours

Selecting a Share Structure

Selecting a share structure is a necessary step for incorporators and directors to finish the Articles of Incorporation. The authorized shares are the maximum number of shares that a business can issue; the issued shares are the total number of shares that shareholders have actually received; and any share classes with specific rights and privileges are part of the share structure.

California does not impose a par value—a minimum price below which shares cannot be sold—like other jurisdictions do. Alternatively, if preferred, the board of directors might set a par value.

Implementing Articles of Incorporation

The formal document required to form a corporation in California is the Articles of Incorporation. The California Secretary of State accepts it by mail, in person, or online for a fee. Form ARTS-GS, the standard form for corporations in California, only allows for one class of shares. Separate documents are required for corporations with more than one class of shares. In this case, it could be wise to consult a business lawyer.

The incorporation documents comprise:

The name of the company and its main office
The street address and name of the corporate process agent
The maximum number of shares that a company can legally issue
Each incorporator’s signature

Having an Organizational Meeting

The incorporators and possibly the first corporate directors (chosen by the incorporators) meet for the first time to make important choices. Most of the time, people who attend the first organizational meeting will:

Create a company records book to keep all relevant documents.
Establish and authorize rules
Choose the first board members and executive staff
Decide on a business bank
Fix the fiscal year for the company
Implement an Incorporator’s Statement
Establish Articles of Incorporation

An incorporator or director is responsible for taking minutes of the organizational meeting and filing them away with the company’s records. Taking minutes of meetings is required by law in California.

Picking the first directors

The company needs a minimum of one director to keep an eye on things. As soon as shares are distributed, a company in the state of California that has more than two owners is required to have a minimum of three directors. A company just has to choose one initial director till they start issuing shares. The election, oversight, and removal of officers, as well as the approval, alteration, and repeal of operating bylaws, are all responsibilities of a corporate director.

It is customary for the incorporators to choose the board of directors or first directors to designate officers during an organizational meeting.

The first corporate directors will keep their positions on the board until the shareholders choose new board members at the first yearly meeting.

Putting an Incorporator’s Statement into Practice

Everyone who served as an original director is named and listed in the Incorporator’s Statement. Until the first shareholders meeting elects the board of directors, the initial directors function in an advisory capacity. It is important to keep the Incorporator’s Statement with the other corporate records.

Developing Company Bylaws

A corporation’s bylaws are the regulations that govern the behavior of its members. It is necessary to hold a special meeting in order to update the bylaws and to keep them current. The bylaws could stipulate:

Corporate governance (directors’ and officers’ responsibilities)
Procedures for holding meetings, casting ballots, and selecting board members
The definition of a “quorum” as it pertains to voting
The time and place of the annual gathering of stakeholders
How meetings will be announced (in California, shareholders must be informed if they are needed or allowed to participate in the meeting).
Management of documents, including minutes of meetings (California mandate)
Dispute resolution procedures
Methods used in contract negotiations
Methods for revising and updating bylaws
A duty of care and allegiance to the company, among other fiduciary responsibilities

Offering Shares

Shareholders can get stock in return for a number of different values, such as money, property, services, or a combination of these. Everyone who owns shares should have their name and contact details recorded in a stock transfer ledger.

Stocks are regarded as securities. If a business files Form D within 15 days of the initial sale, federal law exempts private offers (private, non-advertised sales of shares to a small number of persons) from federal securities legislation. Issued stocks will be considered restricted securities if the corporation claims Rule 506(b) as its exemption.

Similarly, California does not need advertising when selling shares to 35 or fewer unaccredited investors who have either shown investment competence or have prior personal or commercial ties to the company. It is the investor’s responsibility to guarantee that they will not sell their shares.

Within fifteen days after the initial sale, the company is required by the California Department of Financial Protection & Innovation to submit a Limited Offering Exemption Notice (LOEN) and the associated filing fee. Fifteen days after the initial sale, a corporation that is employing federal Rule 506 must file a Form D notification filing along with the appropriate fee.

A company should speak with an attorney if it plans to offer shares to the general public or a big group of investors.

Making a Statement of Information

You are required to file the California Corporate Statement of Information within 90 days after registering a California corporation. After that point, the Statement of Information is submitted annually. You can file it in person, online, or by mail.

Meeting All Tax and Regulatory Obligations in California

To create a corporate bank account, pay taxes at the federal and state levels, and employ people, a corporation has to file for an Employer Identification Number (EIN) or Federal Tax Identification Number (FTIN). The IRS accepts EIN applications through their website or regular mail.

The California Franchise Tax Board is in charge of collecting taxes from all firms based in California. Companies with employees in California are required to register with the state’s Employment Development Department. In order to collect and pay taxes, corporations in California may be required to apply for a seller’s permit if they sell physical goods.

Filing IRS Form 2553, Election by a Small Business Corporation, is required for every California corporation that wishes to operate as a S corporation. The deadline for filing Form 2553 is within two months and fifteen days of the start of the tax year in which it is to take effect.

When forming a corporation, it is important to research any additional licenses that may be required, such as health permits for a restaurant. There is a possibility that licenses may be required at the federal, state, and municipal levels.

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