Start Up Tip: Forming a Corporation


Category: Business Transactions | Commercial Litigation | Corporate

A corporation, or a C corporation, is an independent legal entity owned by shareholders. This means the corporation itself and not its shareholders is held legally liable for the actions and debts the business incurs. Corporations are more complex than other business structures due to their costly administrative fees and complex tax and legal requirements. Corporations are usually suggested for established, larger companies with multiple employees. Corporations offer the ability to sell ownership shares in the business through stock offerings. “Going public” through an initial public offering, or IPO, is a major selling point in attracting capital investment and high quality employees.

Forming a Corporation

A corporation is formed under the laws of the state in which it is registered. To form a corporation, you will need to establish your business name and register your legal name with your state government. If you choose to operate under a different name other than the officially registered name, you will likely have to file a fictitious name or an assumed name, trade name or DBA name (“doing business as”). State laws vary, but typically corporations must include a corporation designation such as Corporation, Incorporated, or Limited at the end of the business name.

You will need to file certain documents, usually articles of corporation, with your state’s Secretary of State office in order to register your business as a corporation. Some states require corporations to establish directors and issue stock certificates to initial shareholders during the registration process. Contact your state business entity registration office for specific filing requirements.

Once registered, you must obtain the necessary business licenses and permits. Again, regulations vary by industry, state and locality. Use the Licensing and Permits Tool on the Small Business Administration website to find a listing of federal, state and local permits, licenses and registrations you will need to run a business.

Corporation Taxes

Corporations are required to pay federal, state and, in some cases, local taxes. Most businesses must register with the IRS and state and local revenue agencies and obtain a tax ID number or permit. A corporation is a separate tax-paying entity. Regular corporations are called “C corporations” because Subchapter C of Chapter 1 of the Internal Revenue Code is where you will find general tax rules pertaining to corporations and their shareholders. Corporations pay income tax on their profits, and in some cases, corporations are taxed twice – first when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns. Corporations use IRS Form 1120 or 1120-A, U.S. Corporation Income Tax Return to report revenue to the federal government.

Shareholders who are also employees of the corporation pay income tax on their wages. The corporation and the employee each pay half of the Social Security and Medicare taxes, but this is usually a deductible business expense.

Advantages of a Corporation

  • Limited Liability. When it comes to taking responsibility for business debts and actions of a corporation, shareholders’ personal assets are protected. Shareholders can generally only be held accountable for their investment in stock of the company.
  • Ability to Generate Capital. Corporations have an advantage when it comes to raising capital for their business. They can raise funds through the sale of stock.
  • Corporate Tax Treatment. Corporations file taxes separately from their owners. Owners of a corporation only pay taxes on corporate profits paid to them in the form of salaries, bonuses, and dividends, while any additional profits are awarded a corporate tax rate, which is usually lower than a personal income tax rate.
  • Attractive to Potential Employees. Corporations are generally able to attract and hire high-quality and motivated employees because they offer competitive benefits and the potential for partial ownership through stock options.

Disadvantages of a Corporation

  • Time and Money. Corporations are costly and time-consuming ventures to start and operate. Incorporating requires start-up, operating and tax costs that most other business structures do not.
  • Double Taxing. In some cases, corporations are taxed twice – first, when the company makes a profit, and again when dividends are paid to shareholders.
  • Additional Paperwork. Because corporations are highly regulated by federal, state, and in some cases local agencies, there are increased paperwork and recordkeeping burdens associated with this entity.
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