Corporations
and Other Business Entities
What is a “C” corporation?
Every “for profit”
business corporation that does not make a subchapter S election with
the IRS is considered a “C” corporation for tax purposes. That means
the corporation will be subject to taxation on its taxable income at
year-end. This is strictly a tax classification that has no other bearing
on the structure of the corporation or the limited liability protection
afforded the shareholders of the corporation.
What is an “S” corporation?
An “S” corporation is one that has
made an election with the IRS under subchapter S of the Internal Revenue
Code to be treated for tax purposes as a “pass-through entity” – meaning
that profits and losses of the corporation are passed through to the
shareholders (owners) who report them on their personal tax returns
and pay the tax at the individual level. The corporation pays no federal
income tax at the corporation level.
Corporations must satisfy
certain requirements to be eligible for S status. To learn more about these requirements and the advantages and disadvantages
of making an S election, go to the Learning Center discussion on Types
of Corporations.
How do I make an election
to become an S corporation?
A subchapter S election
is made with the IRS by completing and filing IRS Form 2553 (instructions
for IRS Form 2553 are here).
When do I have to make
a subchapter S election?
In order for the
election to be effective for the corporation’s first tax year,
the election must be made within 75 days of the beginning of your corporation’s
tax year. The first tax year begins on the date that it has shareholders,
acquires assets, or begins doing business, whichever happens first.
If an election is not made for the first tax year, it may be made in
any following year by March 15 in order for the election to take effect
during that tax year.
What is a Limited Liability
Company or “LLC”?
First, LLC does
not stand for “limited liability corporation” and is not a type
of corporation at all. It is a separate type of business entity that
is of recent origin. Its distinctive feature is that it combines the
limited liability characteristic afforded shareholders in a corporation
with the “pass through” tax treatment provided to partnerships and “S”
corporations.
What is the difference
between an S-corporation and a Limited Liability Company (LLC)?
Both entities provide the benefits
of pass-through taxation to avoid “double taxation” of profits as well
as limited liability for the owners.
An LLC has more operating flexibility and fewer restrictions
than a S-corporation. For example, there are restrictions on the
type and number of shareholders that are permitted in an S corporation
that are not imposed on the member-owners in an LLC. Corporations must
hold annual meetings of shareholders and follow certain other record
keeping requirements not legally required of an LLC.
On the other hand, shareholder-employees of an S corporation
may pay less taxes overall than members (owners) of an LLC. It is generally
less expensive to form an S corporation than an LLC, particularly in
California where additional taxes are imposed on LLC’s.
What is a D.B.A.?
A D.B.A., short
for “Doing Business As,” is a filing made with a governmental agency,
typically a county recorder, when a sole proprietor or other business
entity is conducting business under a name that is different from the
business entity’s name, that is, a “fictitious” name. In some jurisdictions,
this is called a trade name or assumed business name.
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Example: if Paul
Prescott, a sole proprietor, is conducting business as “Paul’s
Printing,” he must file a D.B.A. indicating that “Paul Prescott”
(as the individual) is doing business as “Paul’s Printing” (a
name different from his personal name).
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Example: if Carl
Brown Enterprises, Inc., a corporation, conducts business under
the trade name “Carl’s Fine Shoes,” the corporation must file
a D.B.A. indicating that this trade name is a fictitious business
name registered to the corporation.
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Filing
a D.B.A. is a method of establishing rights to use a particular business
name. It may also be a legal requirement for initiating or defending
a lawsuit in the name of the business.
Forming
a Corporation
Who can form a corporation?
Anyone who files
completed Articles of Incorporation with the Secretary of State, and
pays the filing fee, may form a corporation. Any type of business may
be operated as a corporation.
How many people are
required to operate a business as a corporation?
Legally, only one
person is required to form a corporation – to complete the Articles
of Incorporation and file them with the Secretary of State. This person
is known as the Incorporator and is often an attorney. In most states,
Articles may be filed with the signature(s) of the initial director(s)
rather than being signed by an Incorporator.
After the corporation has been
formed, one individual may fill all of the required capacities: i.e.,
as the sole shareholder and director, and serving as president, secretary,
and treasurer or chief financial officer.
Am I required to have
an attorney form my corporation?
An attorney is not
legally required to form a corporation.
You can file the Articles of Incorporation and handle the other
required filings on your own or through someone of your choosing, who
acts as the Incorporator or organizer of the new entity.
However, if you are unsure of the proper procedures or if you
need advice about establishing or operating a corporation, you should
contact your tax or legal advisor. You should also be aware that filing
Articles of Incorporation is only the first step to legally create a
corporation. Thereafter, other documents and filings must be completed
in order to properly complete the formation of your corporation. If
you fail to properly or timely complete the required steps after filing
your Articles of Incorporation, you may be subject to monetary penalties
and/or the suspension of your corporate rights or even the automatic
dissolution (termination) of your corporation in certain states.
What are Articles of
Incorporation?
Articles of Incorporation
(known in some states as “Certificate of Incorporation” or “Certificate
of Existence”) is the document that legally creates the corporation,
once submitted to and filed by the Secretary of State.
Unlike sole proprietorships and general partnerships, which come
into existence upon commencement of business, a corporation comes into
existence by filing Articles of Incorporation and paying the necessary
filing fee.
What are Bylaws?
Bylaws are a written
document that serves as the internal operating rules for the corporation. Bylaws detail the responsibilities, rights,
and duties of directors, shareholders and officers. As an internal document, the bylaws are not filed with the Secretary
of State or any government agency.
What is a “registered
agent” for a corporation?
The
registered agent, short for “registered agent for service of process,”
is the “mailbox” for the corporation.
It is the person or entity designated by the corporation to receive
any official communication on its behalf, as well as accept service
of any legal process (e.g., a summons and complaint) for the corporation.
The registered agent may or may not be a shareholder, director,
or officer of the corporation. The registered agent must have a physical
address in the incorporating state. The corporation itself may not
serve as its own registered agent.
Do I need a registered
agent for my corporation?
Yes.
Corporations usually designate a shareholder, director, or officer as
the registered agent for the corporation, at the physical address of
the corporation’s place of business.
Corporations that do not have a physical address in the incorporating
state or simply prefer to use an outside registered agent may use a
private service company to act as the registered agent for an annual
fee.
How long does it take
to form a corporation?
The processing time varies in each state.
Normal processing time may be just a few days in states with a small
number of corporate filings. States having large volumes of corporate
filings may take several weeks to a couple of months to process filings.
Many states offer expedited filing services for an additional fee that
reduce the filing times to generally 1 to 4 days.
Keep
in mind that you will need to open a separate bank account for your
corporation to deposit income and pay expenses. Most banks will require
you to present a copy of your filed Articles of Incorporation from the
Secretary of State together with your federal tax number in order to
open a corporate bank account. You should therefore consider expedited
filing services, when available, if you need to open a corporate back
account quickly.
Corporation
Name
Are there any requirements
or restrictions in naming my corporation?
Yes.
The Secretary of State (or equivalent
agency) governs the use of corporate names.
In addition to certain words you cannot use without permission
(such as “bank” or “olympic” or “federal”), the name you select must
not be the same (or “confusingly similar”) as that of an existing corporation
in your state.
Also, an individual’s name, if
used as the corporate name, must include a corporate ending (e.g.,
“Corporation,” “Inc.,” “Company”) to show that the name is not that
of the individual alone. Some states do not permit a corporate name
to be a personal name even with a corporate ending. Alternatively, a
personal name may be acceptable when an additional word is used.
| Example:
Paul Prescott’s sole proprietorship business cannot incorporate
as “Paul Prescott” without including some indication that the
corporation is different from the individual, such as “Paul Prescott,
Inc.” or “Paul Prescott Enterprises, Inc.” |
| Example:
“Paul’s Printing, Inc.” is considered identical to “Paul’s Printing
Corporation” or “Paul’s Printing Corp.” or simply “Paul’s Printing.” |
How do I determine
if my desired corporate name is available?
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California:
The Secretary of State maintains a searchable
corporate (and LLC) name database you may use to determine if
your desired name is available (you can visit it here). Your desired name is checked against existing
corporations with “active” status.
It is not checked against corporations whose status is
“suspended” or “forfeited” or “dissolved,” since such corporations
lose their name rights.
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States other than California:
Most states’ Secretaries of State (or equivalent
incorporating agency) maintain searchable name databases you may
use to check name availability online.
Alternatively, checking name availability via
telephone is an option. Some
states may charge a fee for this service.
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If
I incorporate, will anyone else be able to use my corporation’s name?
Incorporating only
provides you the exclusive right to use your corporate name (or any
name “confusingly similar” to it) in your incorporating state. It will
not keep another business from using your name corporate name
as its business name by filing a D.B.A. for a different business form
(e.g., a sole proprietorship or partnership).
Registering your corporation’s
name as a trademark or service mark, either federally
or with your state, alerts other businesses that you claim priority
rights to use your corporate name within the state(s) in which you do
business. Registering a mark may provide additional protection
that other businesses will not be able to use your name, but the concept
of name ownership is a fairly complex one, and best discussed with your
legal advisor.
If I’m using a D.B.A.
name for my business, does this mean I can use the same name when I
incorporate?
Not necessarily.
D.B.A. names (sometimes called trade names) are generally regulated
by individual counties or other municipalities within a state while
corporate names are regulated by a state agency (Secretary of
State, or Corporations Division). Therefore, since the state agency generally
keeps no record of unincorporated businesses, another corporation may
already have chosen your desired name. Registering a D.B.A. name does
not give you any priority or exclusivity in obtaining that name as your
corporate name.
What do I do if my
D.B.A. name is not available as my corporate name?
Assuming that you
have an established business name and want to continue using it after
you incorporate, your only option is to select a different, available
corporate name and then file a new D.B.A. registering your existing
business name to your new corporation.
| Example:
Your existing sole proprietorship business, Performance Automotive,
is registered to you, Paul Prescott, as an individual. You discover
that there is already an existing corporation named “Performance
Automotive, Inc.” with a business in another part of the state.
You choose a different corporate name, let’s say “Prescott Enterprises,
Inc.” or “Prescott Automotive Enterprises, Inc.” and then file a
D.B.A. indicating that “Prescott Enterprises, Inc.” is doing business
as “Performance Automotive.” In this case, “Prescott Enterprises,
Inc.” is the corporation’s legal name and “Performance Automotive”
is its fictitious or trade name. |
Can I change the name
of my corporation?
Yes. A corporation’s name is designated in the Articles of Incorporation,
so you may change the name by filing an amendment to the Articles.
Your corporation’s board of directors may adopt the name change
amendment, unless its Articles of Incorporation require that the shareholders
adopt the name change. The amendment is filed with the Secretary of
State and a filing fee is paid.
Officers,
Directors, and Shareholders
Must a corporation
have a board of directors?
Yes. The number of directors, however, is a matter for the shareholders
to decide subject to state law and the corporation’s bylaws. Generally,
the number of directors may be a fixed number or a number within a minimum
and maximum range established in the bylaws. The bylaws may be amended
to change the authorized number of directors.
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California:
If the number of shareholders is three or more, then the
corporation must have at least three directors. If the corporation has less than three shareholders, then the
number of directors may equal the number of shareholders.
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States other than California:
Several other states follow the same rule as
California does, e.g., AR, HI, LA, ME, MD, MA, MO, NY,
OH, UT, and VT. The remaining states have differing requirements.
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Must a corporation
have officers?
Yes. A corporation must have certain officers as required by the laws
of each state.
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California:
Three officers are required: President, Secretary, and
Treasurer (or Chief Financial Officer).
The Bylaws may designate additional
officers such as Assistant Treasurer, Assistant Secretary, Vice-Presidents,
etc.
One individual may simultaneously fill all
of a corporation’s Officer positions.
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States other than California:
Like California, some states require three
officers; most states, however, require only two: President and
Secretary.
The Bylaws may designate additional officers
such as Assistant Treasurer, Assistant Secretary, Vice-Presidents,
etc.
Most states allow one individual to hold all
of a corporation’s offices.
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Can anyone be a director
or an officer?
There are very few
restrictions on who may serve as a director or an officer of a corporation.
The most important restriction
is that only natural persons may serve.
This means that a corporation (or any other business entity)
may not serve as a director or officer.
The other restrictions
deal with legal capacity to contract.
Individuals less than eighteen years of age, or who are mentally
incompetent, may not enter into legally binding agreements and therefore
cannot serve as directors or officers.
Does a director have to
be a shareholder?
Restrictions on
directors are specified by state law and the corporation’s governing
instruments.
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California:
There is no statutory
provision requiring directors to be shareholders. Unless the bylaws
contain such a restrictions, a director does not have to be a
shareholder.
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States other than California:
No other states require
that directors also be shareholders of the corporation.
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Can directors
also be officers?
Yes. directors can be, and often are, officers of
a corporation.
Shares
What are shares?
Shares are ownership
units in a corporation, and are evidenced by a stock certificate of
the corporation. A stock certificate indicates the number of shares
issued to a shareholder.
A share entitles its
holder to a proportionate share of the assets of the corporation, whether
by dividend payments or upon the ultimate distribution of its assets
when the corporation is dissolved (terminated).
Shares also confer other rights to shareholders, such as the
right to vote and attend meetings.
Does my corporation
have to issue shares?
Yes, even if you are the only
owner (shareholder). There are two main reasons:
First, issuing shares of stock
is a corporate formality, which must be followed to assure compliance
with all of your state’s statutory requirements with respect to proper
formation of a corporation. Completing this formality is also important
in preserving the limited liability of shareholders.
Second, as mentioned above, shares
indicate ownership of your corporation.
What is the difference
between “authorized” shares and” issued” shares?
“Authorized shares”
refers to the total number of shares that a corporation is authorized
to issue to its shareholder(s) in one or more share certificates. The owner(s) of a corporation decides this number, and it is listed
in the Articles of Incorporation.
“Issued shares” refers to the number
of authorized shares that the corporation has actually issued to its
shareholder(s), as represented in one or more share certificates. This information is not kept on file with any
state agency, but all issuances of stock are recorded in the corporation’s
stock ledger, kept with the corporate minutes.
Why should my
corporation authorize more shares than it issues?
A corporation is
not required to issue all of its authorized shares; in fact, this very
rarely happens.
Directors may want to raise capital
by selling shares of stock to interested investors, or perhaps key employees.
If a corporation has issued all of its authorized shares, it
may not issue more shares until additional shares are authorized – which
must be done by amending the Articles of Incorporation. This process involves completing and filing
paperwork with the state agency, and paying a fee.
It is generally much
simpler to specify a greater number of shares in the Articles of Incorporation
than the corporation expects to issue, thereby avoiding the cost and
delay of amending the Articles of Incorporation at a later time to increase
the number of authorized shares.
How do I
determine the number of authorized shares for my corporation?
First, you need
to determine whether your state (or any other state in which you may
regularly transact business) imposes any fees based on the number of
authorized shares of a corporation. If so, you’ll probably want to stay
within the maximum number permitted without paying additional fees.
If this is not an issue, then the
number is essentially arbitrary and only has meaning with respect to
the number of shares that the corporation has actually issued.
| Example:
Peter and Paul are equal (50%) owners of Paul’s Printing, Inc. A
share of stock has no “par” or specified value. (See later question
for explanation of “par value”). As long as Peter and Paul own the
same number of shares, they are equal owners. It doesn’t matter
whether that number is 1, 50 or 10,000. Depending on the arbitrary
number they select, the authorized number must be at least the
total amount that they will issue to themselves, and should be higher
for the reason specified in the preceding question. Here, Peter
and Paul might decide to authorize 10,000 shares and issue 1,000
to each of them. They will each own 50% of the issued and outstanding
shares, and will still have 8,000 shares of authorized, but unissued
shares that may be issued in the future should it be needed. |
How do I determine
the number of shares to issue to a shareholder?
If the shares of
your corporation have a “par value” (see question below about par value),
the number of shares issued to a shareholder should be a mathematical
calculation based on the value of the items contributed to the corporation
by the person to receive the stock and the par value established for
each share. For example, if the corporation established a par value
of $1.00 per share and a person contributes $1,000 in cash or property
to the corporation, he should receive 1,000 shares of stock.
If your corporation’s shares do
not have a par value, then the number of shares issued to each shareholder
should reflect the ownership percentage that each shareholder is intended
to have. For example, if a total of 100 shares of the authorized shares
will be issued to two shareholders, one of whom will own 75% of the
corporation and the other 25% of the corporation, they should be issued
75 shares and 25 shares, respectively. If they have authorized 1,000
shares and want to issue 500 shares initially to the two of them, the
75% shareholder would receive 375 shares and the 25% shareholder would
receive 125 shares.
What types of
items may a corporation receive in exchange for issuing shares?
Shareholders are
issued shares in the corporation in exchange for contributing to the
corporation money, property or services, or any combination thereof,
which are transferred to and become the property of the corporation.
The contributions become the assets that capitalize the
corporation.
The corporation laws of each state
specify the types of items that a corporation may accept in exchange
for issuing shares. This always includes cash and most types of property
(office equipment, furniture, vehicles, etc.), plus promissory notes,
and past services rendered (but generally not future services). The
board of directors determines the value of any property contributed
to the corporation.
What is “par value”?
“Par value” is a
dollar value assigned to shares of stock, which is the minimum amount
for which each share may be sold.
The board of directors assigns
par value, but there is no maximum or minimum value that must be assigned. Shares may even have “no par value,” which
means that the directors will assign a value, below which the shares
cannot be sold. Value must be
assigned before the shares are issued, since the corporation must
receive consideration in exchange for its shares.
Taxation
and Accounting
What is a Federal Employer
Identification Number (EIN)?
A Federal Employer
Identification Number (also known as an “EIN” or a “Federal Tax Identification
Number”) is a number assigned to a corporation or LLC by the Internal
Revenue Service for purposes of taxation.
A corporation’s EIN is analogous to an individual’s Social Security
Number, in that no two corporations (or businesses) are assigned the
same EIN. Banks require that a corporation or LLC obtain
an EIN in order to open a bank account regardless of whether the
business will actually have employees.
I have a federal EIN
for my existing business. Can I use the same one if I incorporate?
No. If you already have an EIN for your business, you must apply for
a new one when you incorporate. Your
new corporation may conduct business in exactly the same manner as your
previous business entity, but it is a new legal entity and a new taxpaying
entity. Therefore, it must be
assigned a new EIN.
I have a federal EIN
for my corporation. Do I also need a state EIN?
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California:
Yes, once you pay wages exceeding $100. This EIN is used
for completing your California tax reports and deposits. This
number is assigned by the Employment Development Department.
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States other than California:
Many states use your corporation's federal
tax number for state reporting purposes. Other states require
you to register your corporation an obtain a distinct state employer
identification number.
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What is a fiscal year?
A fiscal year is
an accounting year, for tax purposes, that does not end on December
31. A fiscal year must end on the last day
of a month (other than December).
An accounting year ending on December 31 is a “calendar year.”
What accounting
year should I have for my corporation?
If you will be making
a Subchapter S election, you must be a calendar year corporation. If
you will not make an S election, but will remain a “C” corporation,
there may be an advantage in having a fiscal year end if you keep your
accounting records on an accrual basis instead of a cash
basis. This may allow the corporation to “accrue” payments, such as
a fiscal year-end bonus to shareholder-employees, that will not actually
be made for up to 90 days. By doing so, the corporation receives a deduction
in its current tax year, but the shareholder-employee may not actually
receive the bonus until the following calendar year.
Will I have to file
a tax return for my corporation?
Yes. To comply with federal law, your corporation must file a tax return
within 75 days of the end of its fiscal year, whether it is a C corporation
or an S corporation.
A C corporation must file a federal
tax return because a C corporation is taxed on its net income. An S corporation, even though it pays no taxes
on the corporate level, must also file a tax return for reporting purposes.
You will also have to file income
tax returns in most states as well, generally on the same filing dates
as for the corporation’s federal tax return.
What taxes will I
have to pay as a corporation?
As a C corporation,
federal and state taxes must be paid on the corporation’s net income,
unless the corporation if formed in a state without corporate taxation.
S corporations pay no federal tax on net income since it passes through
to the shareholders to report on their personal tax returns.
In California, S corporations are
subject to a tax of 1.5% on the taxable income that is passed through
to the shareholders. California corporations are also subject to a minimum
franchise tax of $800 annually, whether or not the corporation is active
or inactive and irrespective of the corporation’s taxable income. However,
the $800 minimum tax is credited against the total state income tax
for the corporation.
Corporations are also subject to
the payment of federal (and generally state) payroll taxes on salaries
and wages paid to its employees. At the federal level, this includes
Social Security and Medicare taxes as well as a federal unemployment
tax. State payroll taxes often include unemployment taxes and a disability
income tax.
What is withholding
tax?
The term “withholding
tax” refers to any payroll tax that must be deducted or "withheld"
from an employee's paycheck and paid to certain government agencies.
Examples include state and federal income tax, Medicare and Social
Security taxes.
Does my corporation
have to pay withholding tax on the salary it pays me?
Yes. There are two ways to distribute profits in a C corporation: as dividends
to the shareholders, or as salaries to shareholder-employees.
Distributing profits as dividends requires the corporation to
pay taxes at the corporate level since dividends are not deductible
expenses for the corporation, so profits are usually distributed as
salaries, which are deductible expenses.
In the latter case,
the corporation is an employer – and like every employer, it must pay
federal and state (if applicable) withholding taxes on shareholder-employee
salaries.
Likewise, an S corporation must
also pay withholding tax on money paid to its shareholder-employees
as salaries.
Operating
and Maintaining a Corporation
Does my corporation
have to hold regular board meetings?
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California:
Your corporation is required to have an annual meeting
of the shareholders to elect directors.
However, this may be done by a signed written consent without
a meeting.
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States other than California:
Most states permit actions of the directors
and shareholders to be taken by written consent without a meeting
if authorized by the bylaws of the corporation.
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What are my corporate
record-keeping requirements?
As with any other
corporate “requirement,” the answer is dictated by state law, and by
your corporation’s bylaws. Always remember, however, that preserving
the limited liability of the shareholders depends upon proper formation
and maintenance of your corporation as a separate entity. This means
that ongoing record-keeping, such as documenting important events or
activities of the corporation in corporate minutes, is one factor that
is reviewed by the courts in deciding whether or not to hold shareholders
personally liable for corporate obligations.
In many states, there will be very
few record keeping requirements imposed by law, other than having written
minutes of the annual shareholders’ meeting electing the directors for
the year. Complying with this minimum statutory requirement should not
be mistaken for legal compliance with the corporation’s complete record
keeping requirements. It is equally important to document the corporation’s
important activities in the event of an audit of the corporation’s transactions
by the IRS or other tax agency. These activities would primarily include
the financial transactions of the corporation, such a loans between
the corporation and its officers or shareholders, and leasing or purchasing
of major assets.
