Incorporating your business can offer liability protection and tax advantages, but it also comes with added complexities and costs. This guide outlines the key steps to incorporating, from choosing a business structure and name to filing the necessary paperwork. We'll also cover important considerations to help you determine if incorporation is the right move for your business.
[Read more: 8 Types of Organizational Structures for Small Business]
Benefits of incorporating your business
Incorporating your business requires registering it as a separate legal entity. This means that your business will have its own legal identity, separate from your personal identity. Even though incorporation is not mandatory for a business, there are a number of benefits to doing so, such as limited liability and tax flexibility. It's up to each business owner to determine what is right for them.
Here are some benefits to incorporating your business:
- Limited liability: Protects personal assets from business debts and liabilities.
- Tax flexibility: Provides options for different tax structures (C corporation or S corporation).
- Raising capital: Facilitates raising capital through issuing stock.
- Perpetual existence: Ensures the business can continue even if ownership changes.
- Enhanced credibility: Projects a more professional image to customers and investors.
In many cases, incorporation can also simplify finances and regulatory compliance. When in doubt, consult with legal and financial professionals to determine if incorporating is right for your business and personal circumstances.
7 steps to incorporating your business
While every state handles the process differently, there are seven basic steps you should keep in mind.
Step 1: Choose a business name.
One of the most exciting parts of starting a business is picking the name. The main legal requirement is that you cannot use a name that is already taken. Your state has a corporation search service to check the availability of any name you may want to use.
In this era of search engine technology, you also want to consider whether a good online domain name is available for the name you choose. You can use a web hosting service like GoDaddy to check availability.
You also should consider whether you want to use a trademark or logo to identify your company. You will need to search the U.S. Patent and Trademark Office to ensure that your trademark idea is unique.
Step 2: Pick a location.
While you do not need to rush out to rent office space, your business requires an appropriate address. Since many state and local governments restrict where a business can be located, it must adhere to codes and regulations.
Low-cost options for a business address are abundant. Virtual offices and shared workspaces run by companies like WeWork are growing in popularity. You could sublet an office space, or you can even open your business from a rented post office box.
Of course, if you are launching a larger business with several employees, an actual commercial workspace may be a high priority.
In many cases, incorporation can also simplify finances and regulatory compliance. When in doubt, consult with legal and financial professionals to determine if incorporating is right for your business and personal circumstances.
Step 3: Decide on a corporate entity.
There are two primary forms of corporate entities that you can choose from: limited liability companies (LLCs) and corporations.
Limited liability companies
Many small businesses start out as LLCs. An LLC is a hybrid between a partnership and a corporation. An LLC is owned and can be managed by its members, all of whom hold stakes that, when totaled, add up to 100% of the company.
An LLC is created when you file articles of organization with your state government. These are forms that identify the members, managers, and a registered agent for service of process.
While most LLCs do not require a formal operating agreement, it is commonly recommended that an LLC with any significant number of members should consult an attorney to do so.
The operating agreement should cover information about the relationship and responsibilities among the members, the structure between members and managers, how much capital was invested by each member, percentages of ownership, and dispute resolution planning.
[Read more: Sole Proprietorship vs. LLC: Which Structure Should You Choose?]
Corporations
Your other option is to form a traditional corporation, either as an S corporation (S corp) or a C corporation (C corp). There are several key differences between S and C corps.
C corps are usually large, publicly traded businesses. A C corp is owned by its shareholders and managed by its board of directors, with officers in C-suite positions running the company on a day-to-day basis. C corporations are subject to double taxation: once when profits are realized and again when those profits are passed onto the shareholders. Shares of C corps are also bought and sold on the stock market.
S corps are typically intended for smaller businesses. S corps can elect to either have the business taxed regularly or have the business labeled as a pass-through entity. With the second option, the owners pay the business’s taxes on their own personal tax returns. An S corp is also generally managed and run by its owner or owners.
Alternative corporation structures
There are two alternative structures that cater to missions beyond that of a traditional business: benefit and nonprofit corporations.
Benefit corporations
Benefit corporations are for-profit entities that boost a social or environmental mission alongside profits. While they operate like traditional corporations, raising capital and distributing profits to shareholders, the legal structure differs. Directors at benefit corporations balance financial interests with the company's stated public benefit. Examples of a public benefit include environmental sustainability or community development, and these corporations are often required to report on their progress toward achieving that benefit. This approach helps businesses show they care about social impact while keeping their bottom line in mind.
Nonprofit corporations
Nonprofit corporations are organized for purposes other than making a profit, whether charitable, educational, or religious. Unlike traditional corporations, nonprofits do not have shareholders and cannot distribute profits. Instead, any extra revenue is reinvested into the organization to further its mission. Nonprofits typically rely on donations, grants, and fundraising activities to support their operations. This is the only type of corporation that is eligible for tax-exempt status.
[Read more: Nonprofit vs. Not-for-Profit vs. For-Profit: What's the Difference?]
Step 4: File articles of incorporation.
Once you've established your corporate entity structure, the next step is to file articles of incorporation. Depending on your state's requirements, these forms will include an explanation of the shareholder structure and identification of initial directors.
An initial shareholder meeting is then typically held to address formalities, such as stock and bylaws. While adopting bylaws is optional for LLCs, most corporations require them. Bylaws address items like meeting times, voting rights, corporate officers, approval of contracts, and signing of checks.
Step 5: Obtain a tax ID number.
Similar to the way the IRS keeps track of people with a Social Security number, it tracks businesses with an employer identification number (EIN). Applying for an EIN can be done online via the IRS website. An EIN is still required even if a corporate entity doesn't have additional employees.
Step 6: Manage the money.
Once your corporation has an official name and EIN, the next step is to set up a corporate bank account for business expenses.
A corporate bank account establishes the legitimacy and independence of the business and provides evidence of the legal separation between the owner and the business. It also provides the benefit of the corporate shield and its related liability protection and generates ease with taxes and accounting.
Once your corporate banking is established, you and your accountant will discuss the method of taxation that is appropriate for your business. As discussed in Step 3, most LLCs and S corps are candidates for pass-through taxation, while C corps are typically subject to double taxation.
Step 7: File with the state, and secure permits and licenses.
Legal regulations depend upon a variety of factors, such as the type of business in question and its geographic location.
For example, larger corporations have to file with the state after their initial meeting with the board of directors. If stock is being sold, there are federal securities regulations to address.
Typical permits and licenses may include:
- Licenses and permits for the business (i.e., food handler permits).
- Professional licenses for individual practitioners.
- Sales tax ID numbers.
Specific information about these requirements can be found on your state's department of corporations website or small business division.
Ongoing compliance requirements after incorporation
Incorporating your business is just the first step. Maintaining its good standing requires adhering to ongoing compliance requirements, typically on an annual basis. These requirements vary depending on the type of corporation.
Annual requirements for LLCs include:
- Filing an annual report with the state, which often includes basic business information.
- Paying annual franchise taxes, if applicable in your state.
Annual requirements for C corps include:
- Filing a corporate income tax return (Form 1120).
- Holding annual shareholder meetings.
- Maintaining corporate records, including meeting minutes and stock ledgers.
Annual requirements for S corps include:
- Filing an S corp income tax return (Form 1120-S).
- Maintaining corporate records, similar to C corps.
When to seek legal assistance with incorporating your business
While not required by law, legal counsel can give peace of mind to busy business owners. On the other hand, expert assistance may not always be necessary for less complex situations. For instance, a single owner starting a small, low-risk business might handle the paperwork themselves. However, for businesses with multiple owners, intricate financial structures, or significant legal risks, legal counsel can make for a smoother process. If you anticipate needing specialized legal advice related to intellectual property, contracts, or regulatory compliance, consulting an attorney is wise to ensure your business stays in compliance.
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