How to Incorporate: Everything You Need to Know
When learning how to incorporate, you must understand the process. Incorporation is the creation of a corporation under state law. 8 min read
2. Articles of Incorporation
3. Incorporation Advantages
4. Asset Protections
5. Benefits of an LLC and Corporation
6. Incorporating and Taxes
7. The Next Steps
9. Expert Advice
10. Raising Capital
11. Role within a Corporation
12. Follow the Rules
13. Incorporation Disadvantages
How to Incorporate
When learning how to incorporate, you must understand the process. Incorporation is the creation of a corporation under state law. It also covers Limited Liability Companies (LLCs). Incorporating protects personal assets from lawsuits and creditors. You can incorporate by contacting your Secretary of State and asking for the necessary paperwork. You can incorporate without legal assistance, and you can use software or books to help you along the way. Expenses may include:
- Filing costs
- Cost of Resources (i.e. books or software)
- Miscellaneous expenses
Filing with a lawyer can add an additional expense of $500 to $1,000. However, legal assistance prevents you from missing small steps throughout the incorporation process. Additionally, incorporation service companies can help you prepare documents you. Domestic Incorporation Advantages:
Incorporating in your home state provides the following advantages:
- Least complex option
- Less Expensive
- Prevents filing annual reports and paying taxes in multiple states
Articles of Incorporation
To begin the process, file an Articles of Incorporation. Your state provides you with a form, and you or a lawyer can fill out the form. The form will ask:
- The name of the business
- Nature of the Corporation
- Names and Members
- Primary Office
In addition, you need to draft bylaws detailing how the business will be governed, including the rights and responsibilities of:
Further, you need outline a specific time for meetings. Once your state accepts the document, you will receive a certificate officiating your corporation.
You can benefit in the following ways by creating an LLC or corporation:
- Asset Protection: LLCs or corporations separate an owner’s personal and business assets, protecting them liability.
- Credibility: A company with an “Inc.” or “LLC” is viewed as more credible to the public and prospective clientele.
- National Reach: The District of Columbia and each U.S. state recognizes LLCs and corporations.
- Continuous Existence: Both entities exist in perpetuity despite changes in management or ownership. Partnerships and sole proprietorships are not afforded the same luxury.
- Tax Benefits: Any loss or profit passes through an LLC to individual members who would record such transaction on their personal taxes. LLCs can be taxed in the same way as corporations. Corporations can avoid paying double taxes via “S” status.
- Deductions: Both entities can deduct every expenses, supplies, and equipment on their taxes.
Corporations and LLCs provide better asset protections than general partnerships or sole proprietorships. A sole proprietorship is a business entity that exists separately from the owner, and a general partnership is an agreement between multiple party members for the purpose of a specific business goal.
Under partnerships and sole proprietorships, an individual is solely responsible for any liabilities or debts that may arise from the business. For instance, personal items such as personal savings or cars are at risk of judgments or creditor petitions.
Benefits of an LLC and Corporation
Many small businesses choose an LLC because it affords the basics of a corporation with some flexibility and tax advantages. For instance, owners can raft an operating agreement outlining the structure of the business. Corporations use a similar document called bylaws, which set forth rules and operating procedures for members. Corporations also issue stock shares to members, while LLCs divide profits among members. The government taxes corporations at lower rates than individuals.
Incorporating and Taxes
The type of taxes you’ll pay depends on the structure you choose. For instance, C-status corporations will file Form 1120 with the IRS, which taxes profits and dividends that are issued to shareholders. With that, corporation can choose the “S” classification, which allows a method known as pass-through taxation. Pass-through taxation funnels profits and losses to individual members so they can pay their taxes on personal returns. S classification allows members to prevent double taxation that comes along with C status corporations. The IRS taxes C corporations at the profit and shareholder levels. With that, S corporation have certain limitations, such as not being allowed to have over 100 shareholders, but members are provided the same level of personal liability protection.
The Next Steps
After incorporation, owners should apply for an Employer Identification Number (EIN). An EIN is a system used by the government to identify your corporation, and you need one if you intend to hire employees. You can go to the IRS website to get one for free.
Licenses and Permits
Permits and licenses will be necessary regardless of your business. Depending on the nature of your business, you may need state, local or federal licensure. For example, you may need a local business or signage permit in your county. Contact your state authorities to find out what type of regulations you may need to satisfy.
Bylaws and Operating Agreements
To officially define your company, you need to establish bylaws under a corporation and operating agreement under an LLC. Both provide cohesion to your business and define the roles and responsibilities of each member. Further, such document tells members what to do in the event of an unforeseen circumstance, such as the retirement or death of a member.
Maintain Your Company
Regardless of the entity you choose, ensure that crucial paperwork is submitted on time. Annual reports, for example, are crucial documents you need to submit each year to maintain your LLC. Failure to do so could result in the suspension or dissolution of your business.
A person can incorporate his or herself. Incorporation would provide more credibility when compared to a sole proprietorship. Self-incorporation also protects you personally from any liabilities. Doing so also provides the following advantages:
- Increases your changes of gaining financing (lenders view corporations as more steady than sole proprietorships)
- Dividing personal and business assets
- Simplifies the tax process
Self-incorporation requires a specific amount of paperwork, which depends on your situation. Improper filing could delay the process or disrupt business activity. Ask your state authorities regarding the standards for self-incorporation, or talk to a legal expert.
An expert can help through the most complicated measures when it comes to starting a business. Professional counselors will help you make important decision and will help you spot overlooked areas of the process. The process is not as cumbersome as you would believe, as many firms do away with lengthy questionnaires and red tape. Legal advice can:
- Protect personal assets
- Help you save on your taxes
- Help you gain instant credibility to your business
- Expedite the process faster
Experts have helped business owners make the right choices when forming a corporation.
Further, expert advice may not be as unaffordable as you would think, especially when considering the costs of missteps and wrong decisions. Additionally, a legal team will help you solidify your business strategy and will help you choose a structure that will help your business succeed. Moreover, legal counsel can help you choose a business name that is unique and will stand out to the public.
Most venture capital firms and investors prefer to lend money to C corporations, which is the standard classification for most corporations. LLCs and other business entities receive less funding due to the uncertainty of rules and regulations of each state. Further, other entities do not have the familiar structure of directors, shareholders, and officers that many investors are accustomed to.
While a C classification is best if you plan to raise money, it is also important to be realistic if you are a small corporation. For example, you should choose an S classification if your shareholder count is 35 or less. S classification provides more tax advantages for smaller corporations. Moreover, you can change to C status if you have more than 35 shareholders in the future.
If you’re working any stock grants or investor agreements, you should contact a securities attorney. Such issues can get complex, and missteps may cost your company benefits.
Note: Legal counsel should not be involved in the company in any fashion and should be an unbiased party. An object presence will also point out any weaknesses in your organization while ensuring that your firm remains compliant under the law. Conduct research on prospective counsel, and defer to The State Bar hotline if you suspect the legal advice you’re getting is unethical.
Role within a Corporation
When creating a corporation, remember the role that each member will play in your organization.
Board of Directors: Directors are mentioned in the Articles of Incorporation. They manage operations of the company and ensure it is running at top efficiency. The primary aim of the board is to manage in a way that is in the company’s interest and not for their own personal benefit. Also, they must protect the investments of shareholders. The board may choose a single representative to represent the interest of the collective. The board has authority over all officers of the company. Officers are managers who operate the everyday affairs of the business.
Shareholders: Shareholders receive stock from the corporation. In exchange for money, the investor will be given shares of the corporation. Typically, investors will choose what is known as preferred shares, meaning that they will get their money first before common stock shareholders if there is a shortage of dividends. Stockholders meet yearly during the company’s annual gathering and will elect a board of directors. Investors rely on the board to ensure profit is maximized in pursuit of a good ROI. Shareholders do not absorb any liabilities or debts of the business and are not accountable for any type of wrongdoing.
Officers: Officers usually include a CEO, treasurer, CFO or president. The board has the authority to appoint and fire officers of the corporation. The goal of the officers is to secure a smooth operation of the business and satisfy the interests of shareholders.
Follow the Rules
After your corporation is established, be sure to follow the rules and responsibilities that come along with incorporation. Follow your state guidelines, and keep detailed financial records of the business. Most importantly, record a separation of business income/expenses and the owners. Failure to maintain records and follow the rules could jeopardize your business and open yourself up to personal liability, regardless of which entity you choose.
Remember to allocate the appropriate stock and file annual reports as required under law. In addition to conducting annual meetings, you must record the minutes of the meetings. Whenever conducting business, be sure to identify your company using “Inc.” or “Corp.” You want every person you deal with to know you’re a corporation.
If you are unsure of which rules to follow, consider these basic steps:
- Call your Secretary of State to make certain your business is in current status
- Make sure all names are recorded properly during the singing of contracts
- Use your official title after signing a contract (ex. John Smith, President of XYZ instead of just John Smith)
- Avoid using a DBA (Doing Business As) on contracts. If you have done so in the past, renegotiate the contract.
- Write corporate resolution regarding any major purchase of assets. All forms should be recorded on corporate books.
Incorporation provides a wide array of benefits, but you must always be aware of the risks and drawbacks:
- Corporations are required to conduct annual meetings, and members must confirm to some formalities.
- Corporations are costlier than sole proprietorships or partnerships.
- Owners must satisfy regular filings and fees.
To find out how to incorporate in your state, post your legal need on our marketplace. UpCounsel’s top lawyers will assist you during the incorporation process so you can avoid mistakes and missteps that could get your business off to a rocky start. Our lawyers have graduated from the finest law schools around the country and have worked with such notable companies as Menlo Ventures and Google.