Have an idea for a business but you’re unsure what form your business entity should take? There are options for protecting your personal assets whether you create a corporation or an LLC. While we don’t recommend California as the best possible location to incorporate due to unavoidable high tax rates, we do understand that sometimes it’s what needs to be done.
What is a Corporation?
A corporation is a legal entity and a form of business operation which is created by individuals, stockholders, or shareholders. Each member of a corporation owns a portion (or slice) of the pie. The purpose of a corporation is to operate for profit. A corporation is a distinct and separate entity from those who own and operate it, and under the law, possess many of the rights and responsibilities as an individual.
Corporations are generally taxed independently from their owners and are run by a group of selected individuals known as a board of directors. Corporations pay taxes based on their net income or profits every year based on a calculation of tax liability which is determined by filling out IRS Form 1120.
In many respects, a corporation is seen as a legal person based on the rights and protections, as well as the expectations, extended to them.
How Does a Corporation Work?
A corporation is created by going through the lengthy and complicated process of incorporating, which is how a business is formally organized and officially made to exist. There are numerous documents that must be prepared and filed. Corporate bylaws must be established to govern policy, articles of incorporation must be submitted to the state, and a board of directors must be elected in order to set policies and manage oversight. The board of directors also must ensure the corporation is acting in accordance with its bylaws and its mission, and that it complies with government regulations.
The board of directors are elected by the shareholders who own the corporation. This happens during an annual general meeting where each shareholder is entitled to a single vote per share. These shareholders don’t run the corporation by default, but they can be elected as part of the board of directors or as corporate executives.
A corporate executive is a paid employee who is just one level under the board of directors. They ensure that the business operates as desired by the shareholders. Executives or directors elected by the shareholders are expected to act in the best interests of the corporation, or they can be voted out and replaced by someone else who will.
How Do I Start a Corporation?
The process of incorporation in California is very similar to starting an LLC. There are a few differences that complicate the process. We recommend having our legal experts guide you through the following six steps:
1. Create a name for your corporation.
The public will need to know what to call your corporation. Having a name that is easy to remember and help explain what your corporation helps. There are, however, some naming guidelines that must be followed.
California naming guidelines:
Your corporation’s name must include “corporation,” “company,” “incorporated,” “limited,” or some form of abbreviation of any of these words. People must be able to distinguish between your corporation and any other corporation that already exists. You can do a business name search using California’s business search tool on their secretary of state website.
Your name must not use words like “bank,” “trust,” “trustee,” “credit union,” or any such related words without the express permission from the Department of Financial Protection and Innovation. You must also avoid words that might confuse your corporation with a government agency (FBI, State Department, Treasury, etc.). Make sure to read California’s code of regulations for business entity names for more information.
You will also need to check for the availability of a good URL for any web domains you want based on your business name.
2. Choose a California registered agent.
You must have an appointed California agent for service of process, or registered agent, when you register your corporation with the California Secretary of State. A registered agent is a person appointed by an LLC or corporation who is designated to correspond with the government on behalf of that business. They will receive service of process, government correspondence, and compliance documents on behalf of the business. In order to qualify to be a registered agent, they must be 18 years of age or older, have a physical address in the state of California, and be available during normal business hours. A member of your corporation or any qualified individual can serve as your registered agent.
3. Hold an official organizational meeting.
Before you can become official by filing your articles of incorporation the shareholders must complete the following requirements:
Create and approve your corporate bylaws.
How your organization is governed and run is determined by your corporate bylaws. These are essentially the constitution of your corporation and determine the rules and priorities of the corporation. These bylaws will supplement rules set by the federal or state government. It is important that these bylaws include:
- - Who governs the corporation
- - The roles of directors and officers.
- - When and how meetings are held.
- - Voting procedures and how to elect officers or directors.
- - How records are kept and maintained.
- - How to handle corporate disputes.
- - Ways to add or amend corporate bylaws
- - The annual shareholder meeting date.
- - How to negotiate contracts.
- - Establish fiduciary duties to the corporation.
- - What must constitute a quorum for the purpose of voting.
Appoint the initial director(s)
One or more people need to be assigned as director in charge until the first shareholder meeting. A corporate director determines how corporate operational bylaws are implemented or repealed, and they oversee the election and removal of officers. After the corporation is formed, the initial director should call an organizational meeting to then elect the board of directors and appoint the executive officers.
Choose a share structure and strategy.
A unit of ownership in a corporation is measured by a share of stock. Shares of stock represent a percentage of ownership for a company. If there is a single stock for a company, then the owner of that stock would own 100% of that company.
Shares are structured into different classes. Each of these “share classes” hold a different right and privilege. You can have multiple classes, with each class holding any number of shares.
Create and Execute an Incorporator’s Statement
An incorporator is the person responsible for registering a corporation with the state. They must file the paperwork and sign the articles of incorporation. A business cannot be formed legally without an incorporator. They must sign an incorporator’s statement with the name and address of each initial director and keep a record of it in a corporate records book.
4. File the California Articles of Incorporation.
In order to set up a corporation in California you will first need to file your articles of incorporation. This is a document that officially establishes your corporation in California. It can be filed in person or by mail with a filing cost of $100. Included within the document are these details:
- Corporate name and principal address.
- Service of process name and street address.
- The number of authorized shares issued by the corporation.
5. File the California Statement of Information.
A California Statement of Information form must be submitted within 90 days of the registration of your California corporation. This is a biennial report meaning it must be filed every other year. The filing cost is $25. The statement of
- Your corporation’s name and street address.
- The names and addresses of the board of directors and the executive officers.
- The designated registered agent and their address.
- The type of business your corporation will provide.
- An entity number.
6. Get an EIN for Your California Corporation
An Employer Identification Number (EIN), or Federal Tax Identification Number (FTIN), helps the federal government identify a business entity. It’s assigned by the government and is essentially a social security number for your company. You will need this number:
- To have access to business bank accounts for your company
- For Federal and State tax purposes
- To hire workers for the company
You obtain this number for free by either filing online or by downloading and filling out a form SS-4 and mailing it in.
Do You Need Help Starting a Corporation?
Given the relative complexity of all the required steps involved in forming a corporation compared to forming an LLC, we recommend some form of legal assistance. Contact us for more information to find out if you have everything you need.
Why Start a Corporation?
There are several great reasons to incorporate, and here are a few of them.
- Professionalism - In terms of appearance, no business structure appears more professional than a corporation. A professional appearance makes it easy to obtain funding, apply for loans, and be taken seriously. Corporations can also establish credibility with customers, employees, and potential vendors.
- Separate Entities - Corporations officially establish a difference between the business and the owner. In terms of who owns what, this allows the business to enter into its own contracts, own property, and pay taxes.
- Limited Liability - Doing business under the name of a corporation offers a degree of liability protection. Being able to separate business assets from personal ones helps to protect the individual. Instead, pursuits of payments owed must be done directly through the corporation.
- Privacy - Depending on the state you form a corporation, you can form anonymously. While that isn’t the case in California, forming a corporation with a registered agent provides some privacy. If a lawsuit is filed against a corporation the names of the owners can stay hidden while the debts are collected.
- Tax Advantages - Corporations are given some tax deductions that aren’t available to sole proprietors. Corporations can deduct business expenses associated with providing benefits like health insurance premiums to employees. Corporate income doesn’t require the same social security payments, as well as worker’s compensation and Medicare taxes that are paid by LLCs.
- Transfer of Ownership - Due to the ownership being based on who owns shares, it’s very simple to transfer ownership from one person to another. No approval is needed from other shareholders.
What Different Types of Corporations Are There?
There are three main types of corporations: C corp, S corp, and Nonprofit. Another type of business entity you might consider a corporation is an LLC. Here is a brief description of these and the purpose of each.
- A C corporation is what you think of when you imagine a company. It’s the default structure, representing a different legal entity from its owners. It has a basic operational structure with shareholders, executive officers, board of directors, and employees. The owners are taxed based on the profits they receive and the business is taxed as a separate entity.
- An S corporation is a different tax designation that can be assigned to corporations as well as LLCs. They are taxed as pass-through entities, meaning they don’t pay federal taxes on business income. The profits instead pass directly through to the shareholders.
- A nonprofit is an organization formed for religious, scientific, literary, charitable, or educational purposes. They are eligible for federal and state tax exemptions. They are also known as 501(c)(3) organizations. To create one you must first form a California nonprofit corporation, then apply for tax-exempt status with the IRS and the state of California.
- A limited liability company (LLC) is very similar to a corporation in the sense that it provides certain business securities. It has many of the same benefits of a corporation without the complexity. It’s not quite as complicated to create an LLC in California.
Advantages of a Corporation
- Separate legal entity - Having a corporation can separate the business from the owner(s). The business is considered separate and it may conduct business, own properties, enter into contracts, borrow money, pay taxes, and be sued independently.
- Unlimited life - Due to the ownership of a corporation being represented by shareholders, it is easy to transfer ownership from one person to another. This means should something happen to a shareholder, their death or inability to perform their duties is easily transferred to someone who can function as the corporation needs. It takes changes in the company’s charter to liquidate or dissolve the corporation.
- Limited Liability - Assets of the company are separated from the personal assets of individuals involved with running the corporation. Owners are only liable for the amount of money they invest and this protects personal assets from creditors or lenders who may try to collect on money owed.
- Easy transfer of ownership shares - Approval from other stockholders is not required when transferring from one to another. This makes ownership easy to transfer. Stocks or shares can be traded in the market regardless of their volume.
- Competent management - Owners or investors delegate day-to-day business operations to the board of directors, who will in turn hire a professional management team.
- Source of capital - Funds can be sourced from stocks and bonds in a corporation.
Disadvantages of a Corporation
- Incorporation costs - The process of incorporation is costly compared to forming a sole proprietorship or a partnership.
- Double taxation - Taxes are remitted from both corporate earnings and from payments of dividends to shareholders.
- Documentation - There is a lot of paperwork involved with corporations. After filing incorporation documents, there are annual reports and tax returns that must be filed, as well as maintaining accounting records, licenses, and more.
Should You Start a Corporation?
A corporation can be a great start to grow your business. Though it might be simpler to start an LLC, you might prefer the corporation route. Whether you want to go public or avoid double taxation as an S corp, a corporate structure can provide you with some tax benefits and help you establish credibility as a California business.