What Does Incorporated Mean: Everything You Need to Know
Incorporation gives the owners several advantages, chief among them being the separation of the business from its owners as a distinct entity.8 min read
What Does Incorporated Mean
If you’re looking to incorporate a business, you may wonder “what does incorporated mean?” It’s just the classification used to describe any company that has completed a state’s incorporation process. The definition is simple, but the process is lengthy and complex. You’ll need to understand all the advantages and disadvantages before choosing to start this journey.
What Does Incorporated Mean in Business?
A business can consider itself incorporated once the full process of becoming a corporation has been completed per the laws of the incorporating state. Incorporation gives the owners several advantages, chief among them being the separation of the business from its owners as a distinct entity. An owner can start a business by structuring it as any of the following: a sole proprietor, LLC, corporation, or partnership. The corporation is the only business structure out of those listed that is entirely separate from its owners as a legal entity. If you want your business to become incorporated, there are many pros and cons to consider before moving forward with the process.
What is a Corporation?
Here are a few distinctions that separate a corporation from other structures.
- Shareholders can limit their liability to their direct investment, which limits the liability to their personal assets.
- Corporations act separately from their owners or shareholders.
- Corporations can be sued or sue others.
- A corporation can file the company's own taxes.
- Profits and losses are taxable to the corporation, not the shareholders.
- A corporation affords the owners limited liability.
- If the owner dies, the corporation will live on.
How to Form a Corporation
Corporations are creatures of state law; therefore, the particular state where a business is incorporated will determine how a business must establish the corporation. Corporations exist as a result of state laws. Because of this the process of establishing a corporation depends largely on the state where it will be incorporated. Usually, articles of incorporation are drafted by the founders with the Secretary of State or another appropriate agency. Some states will require that corporations name their business something which clearly denotes that the business has been incorporated. This is most easily accomplished by adding “Inc.” to the end of the name of the business. By having that small designation at the end, customers and interested parties are made aware that this business is in fact a corporation.
Companies will need to continually adhere to the continuing disclosure rules of the state such as fee requirements and annual reports. You will need to decide whether you should incorporate your business as a C corporation or an S corporation
- C corps are more common. C corp is a separately taxable entity where tax is paid on the corporate level and at the individual level on dividends.
- An S corp is considered a pass-through tax entity. S corp pays no corporate income tax but the profits and losses of the business are “passed through” the business and reported on the owners’ personal income tax returns.
- C corporations are not restricted on ownership where an S corporation cannot have over 100 shareholders, and each one must be a U.S. citizen.
Corporations should determine what state to incorporate in. It is important to choose in which state you want to become incorporated. The natural choice is to incorporate in your home state. However, there can be distinct advantages for your business in other states. Delaware, for example has made significant advances in their business court system. Many companies like incorporating in Wyoming or Nevada because neither has any franchise or income tax for corporations. In Wyoming, there is also no personal state income tax.
Once you’ve chosen the best location to incorporate, it is time to appoint a registered agent and directors. Your registered agent is someone who can receive important tax or legal documents on behalf of the business. Registered agents also must acquire tax or legal documents during a standard business day. After that, it’s time to prepare and file the articles of incorporation as well as any other necessary documents with the appropriate Secretary of State. In most cases the articles of incorporation is just a simple fill in the blank document. Then all that’s left is the pay any applicable filing fees, and let the process finalize.
Benefits of Corporate Form
Where partnerships usually have an expiration date, corporations enjoy an unlimited lifespan. This means the corporate form can indefinitely continue if the shareholders or the board of directors don’t decide to terminate it. Corporation is a significant process because the state laws for partnerships generally dissolve partnerships when the partners leave by default. Along with unlimited life, choosing the corporate form will offer protection from any personal liability for the corporation’s shareholders. Further, the shareholders have no liability for the debts or actions of a company beyond their own investment. This naturally does not apply in the case of any willful wrongdoing.
Corporations also enjoy lower tax rates than an individual would. This means that a corporation can grow their earnings with more tax efficiency that a sole proprietorship or partnership wherein the taxes would be passed on to the owners. They can also more easily raise capital by selling stock in the company. There are many classes of stock allowing it to be used as a reward for employees alongside their compensation. Should the corporation choose, they can take steps to make their stock publicly traded.
Other benefits include:
- A credit rating separate from the owners of the corporation.
- Healthcare as a tax writeoff.
- Creditors cannot pursue the personal assets of an owner in the business is sued.
- Plenty of legal precedent to use as a guide and template.
- The clearest path to becoming a public company.
Disadvantages of Corporate Form
The biggest drawback of incorporation is the issue of double taxation. This occurs when a corporation must pay taxes on its profits and those same profits have been shared with stockholders as dividends. The shareholders then must include the corporation’s stockholder dividends as a part of the personal income of the stockholder for that tax year, and are then taxed on that revenue a second time. The filing fees are also greater for corporations than any other entity.
A corporation must keep track of more records, including their bylaws, minutes of annual meetings, communications with shareholders, annual reports, and the articles of incorporation. Ultimately, the up-front costs of a corporation are far higher than for sole proprietorships or partnerships.
Owners in a corporation will likely be liable only for any losses or obligations based equivalent to their personal investment in the company. If a shareholder signs a corporate loan with a personal guarantee, they could be liable for the debts of that company. Nothing about the articles of incorporation protects a shareholder if they engage in any criminal activities. They’ll be held accountable as an individual.
Corporations are expected to maintain accurate records of their banking which remain separate from any personal funds of the owners. They will also need to file their annual reports and taxes with the state where the company was organized. Shareholders cannot deduct any dividends they’ve received, and these will not reduce the tax liability of the corporation.
One of the biggest aspects separating a corporation from a partnership or sole proprietorship is that a corporation can issue stock out to investors and employees. Any shares that have not been issued can be sold when the company needs to raise funds. Investors will be more interested in a corporation than they would a sole proprietorship or partnership because incorporated businesses have limited liability protection. Stock incentives for employees are a reliable method of attracting highly talented candidates when you need to hire for new positions.
A corporation has a separate existence wholly apart from the shareholders who run the corporation. The main reason to incorporate is to separate the company from its shareholders as an entirely distinct entity. Further, a corporation can exist far beyond the lifespan of a certain person or group, unlike a partnership or sole proprietorship.
Ultimately, there are six main reasons to incorporate a business. They include tax flexibility, enhanced credibility, perpetual existence, deductible expenses, brand protection, and personal asset protection.
Transferability of shares
The ownership of a business is able to be transferred, given away, or sold to any member of the owner’s family. All the rights of individual owners in a corporation can be represented by their shares of stock in the company. The most important component to a fast and efficient ownership transfer of a business is found on the back of every stock certificate indicating the shareholder to sign over and endorse any and all shares that will be sold.
To begin the process, be sure you ask for forms, fee schedules, and instructions on business incorporation. It may be impossible to file for incorporation alone without an attorney’s help. Some people try to use software or books, but the process is still difficult.
The expense to the owner will end up being the combined cost of filing fees, resources, and any other costs that come up. Filing for incorporation without legal help can save up to $1,000 by cutting out the cost of hiring a lawyer, but it will make the process take much longer. You might also miss some minor, crucial detail about the incorporation laws of your chosen state.
Where to Incorporate
In any state besides the one where it was incorporated, a corporation will be considered a “foreign corporation”. If any of a corporation’s business transactions take place in another state, they might have to register for that state’s certificate of authority to transact business. This is also called a foreign qualification. What actually constitutes “transacting business” will vary from state to state. Should a corporation fail to provide the necessary paperwork, it could forfeit its access to the courts of that state and would then be facing penalties and tax fines.
Any foreign corporation will still have to pay the state filing fees for its qualification filing. These will be cost more than if they filed for a domestic corporation.
If a company is transacting business through the internet or mail-order, usually this will not officially constitute transacting business, but it depends on the specific situation.
Most companies incorporate their business in states there all the members live and will conduct the majority of their business. However, many choose to incorporate in states where the process is better suited to their needs. Some of the best options include Nevada, Pennsylvania, Connecticut, California, and Delaware.
How Incorporating Affects Funding
Should a corporation choose to seek out investments, investors and venture capitalists will generally prefer to invest in a C corporation. They don’t usually like investing in other entities like partnerships because the rules of different states vary so wildly. Partnerships also lack the strong legal structure of officers, a board of directors, and shareholders found in corporations, which are highly attractive to investors. That said, generally corporations with under 35 shareholders will generally choose to become S corporations specifically for tax purposes.
A few other quick notes:
- Corporations should file their election form 2553 shortly after they are incorporated and should also check in with the IRS to be sure that everything was properly filed by the deadline.
- The attorney of the corporation shouldn’t be a shareholder or board member.
Ultimately, there are many advantages to incorporating. It allows a company to last far beyond the lifespan of its founders and provides many tax and legal benefits. It can be a complicated process, but may be exactly what your company needs to continue moving forward.
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