How Are Corporations Formed?
A corporation is a type of business, created by law, which is a separate legal entity owned by shareholders and managed by directors. Corporations are organized under state law, and each state regulates corporations formed in the state. The steps necessary to incorporate include the following:

• Preparing and filing charter documents with the State’s Secretary of State
• Preparing the bylaws
• Holding the first organizational meeting of the directors
• Establishing books and records for the corporation
• Filing reports that may be required by the various states

What Are the Differences Between a Corporation, Partnerships and a Sole Proprietorship?
You may start your business as one of several different types.

What Are Some Advantages of Forming A Corporation?
The reasons most people incorporate their business:

1. Is to limit their exposure to personal liability and business debts. A corporation protects personal liability for the corporate owners (the shareholders) in most cases.

2. To take advantage of tax benefits, and corporate allowable deductions for expenses such as health insurance, employee benefit plans, negotiating financing, as among other tax benefits.

3. A corporation can exist in perpetuity. What this means is that the business can continue in the same form, after you retire. You can sell the business, as a corporation, or set up a vehicle such as a family trust, to leave it to your children or relatives – which you can do even while you retain of the day to day activities of the corporation. The reason you can do this is because unlike a sole proprietorship, a corporation is owned by the shareholders so therefore a company exists as a total number of shares. Therefore, if a company has 200 shares, then the company exists as the total of 200 separate parts. Public companies may be made up of hundreds of millions of shares. Additionally, shares can have different type of voting classes. Some shares may be allowed to vote and others may not. The most common types of shares are called, not surprisingly, "common" shares. Preferred shares mean that they are somehow different than common shares, and there may be several types of preferred shares, each with slightly different rights or even dividends than the common shares. Many people use shares and share classes to assist in transferring their business to their children and relatives in estate planning. Proper estate planning can reduce or eliminate the high tax cost on an estate.

4. Corporations give their business substance and credibility in dealing with other business, lenders and the public. This can be helpful when a corporation wants to borrow money, buy other businesses, enter into contracts, assume debts and liabilities to build the business

Other Business Entities
An Individual Proprietorship is the oldest and simplest and has been the most common type of business formed. The individual keeps all profits and expenses. The business is personal to the proprietorship and ends when the person who owns the business closes up the shop. An example would be "Jane Doe doing business as Jane's Pizza". Jane is running an individual proprietorship. Why do so many people run their business as an individual proprietorship? Because it is very easy to set up, and very few requirements to keep going. The big downside? The proprietor has unlimited liability for herself and for those who work for her. That’s why many people decide to incorporate their business.

A Partnership is a legal relationship between two or more persons, each who are "agents" for each other and the partnership. A partnership, with some exceptions, is an extension of an individual entity. Here is an example: Jane has a business "Jane’s Pizza." Jane has a friend, Jill. Jane wants to bring her friend into the pizza business. One choice of business could be a partnership such as "Jane Doe and Jill as partners, doing business as Jane's Pizza". Notice that you do not have to change the name of the business to show that it is now a partnership. Jane and Jill can bring in Jack to be a third partner. (Jane Doe, Jill and Jack as partners doing business as Jane’s Pizza) There are several type of partnerships, general partnerships and limited partnerships and a recently new form of this, the limited liability partnership (the LLP). A partnership is also easy to set up, but now, besides having unlimited liability for your own actions, you are also liable for your partners’ too!

So, Jane, Jill and Jack have been running their business for awhile or they want to start a new business. Or Jack is worried that someone may slip in the pizza store and sue them each personally. After doing their research and learning about corporations, or after to an business professional, they decide they want to incorporate their business as Pizza Girrl, Inc. (Jack has been outvoted as to the name of the corporation.) The corporation must be named something ending in "Inc.", "Incorporated", "Corp.", or "Corporation". The partners decide they can incorporate themselves, and so now after forming the corporation, Jane, Jill and Jack now own shares in Pizza Girrl Inc. They each elect themselves directors of the corporation. Directors are normally the people who make day to day decisions of the corporation and are responsible for every day management. Starting a corporation has protected them from being personally liable for most type of lawsuits against the business.

Types of Corporations
Once you have decided to incorporate, you have options to the type of corporation you can elect. You may have heard corporations called by various names including a general corporation, a close corporation, a 'C' Corporation, or an 'S' Corporation. Additionally there are specialized types of corporations such as non-profit corporations, professional corporations, as well as others.

How Long Does It Take To Incorporate?
Depending on your state, a corporation may be formed within a day to up to a few weeks. Many states charge an expedited fee to speed up the process. You can check our incorporation form to see if this is available in your state.

Benefits of Becoming an S Corporation

• Tax Benefits

This "double taxation" problem usually arises in a small corporation when a shareholder doesn’t draw a salary, and only receives money from the corporation as dividends. Otherwise, to avoid this problem altogether, you might just raise your salary and avoid dividend distribution. However, if you pay yourself too much, the IRS may decide that your "salary" is really a dividend and disallow your salary. As an 'S' Corporation, your corporate profits always flow to the shareholders, so that the question of excess salary doesn’t come up, and "double taxation" is not a problem.

• Social Security Tax Saving
  

That’s why most small businesses become 'S' Corporations when they can (and if they meet the necessary requirements.) An 'S' Corporation differs in the extent of how the IRS taxes the corporation. Additionally there have been many changes made by the Federal Small Business Act of 1996, which offer the 'S' Corporation many potential advantages. The IRS allows all profits of the corporation to pass through to the shareholders, and eliminates the double taxation of corporate profits. An 'S' Corporation is a 'C' Corporation that "elects" to be an 'S' Corporation. Losses by the corporation are taxed differently too. For example, as an 'S' Corporation, Pizza Girrl, Inc., is limited to the amount and type of shareholders it can have. No more than 75 shareholders can have stock of an 'S' Corporation. Profits of Pizza Girrl, Inc. are passed through to Jane, Jill and Jack as regular income and there is no corporate tax to be paid separately. Should Pizza Girrl, Inc. lose money, Jane, Jill and Jack will also be able to deduct their losses in their personal tax returns (in most states). They could not do this as a 'C' Corporation. Other requirements for a 'S' Corporations are that all shareholders be citizens or residents of the United States and that all shares issued are one class of stock. To start your corporation as an 'S' Corporation a filing must be done within 75 days of incorporating.

Professional Corporations (P.C.)
Generally, you can form a professional corporation (P.C.) if you are a licensed doctor, dentist, chiropractor, physical therapist, and pharmacist. Other professional corporations may be formed for accountants, social workers, massage as well as landscaping and architects. All shareholders must be licensed to practice the same profession, and no one may be a shareholder who isn’t licensed in that profession. You will need a copy of each director’s license in order to form the corporation. A professional corporation (P.C.) can have as little as one shareholder.

What Are The Guidelines For Naming My Corporation?
You can form your corporation as long as it falls within specific guidelines.
1. The corporation name must end in Inc., Incorporated, Corp., or Corporation.

2. It may not be a name that already is taken in your state. (Example - You could not name your company IBM in NY because IBM is already incorporated there)

3. You can not use a deceptively similar name. So, you probably could not call your company IBM to sell computer equipment. Not to mention, you could get sued by the owner of a trademark for using their name even if the state allowed you to incorporate it.

4. You may not use a name from the state’s list of prohibited words or restricted words. Most states will not allow you to use words such as police, state trooper, blind, bank, insurance, union, school, and others without first obtaining state approval. You should be ready with more than one name when you incorporate. Should your first choice already be taken, you will use your next choice. The Secretary of State will check to see if your name is taken by some other company when you incorporate.

How Many Directors Do I need?
Most states allow for one person to carry all the titles of President, Vice President, Secretary and Treasurer of a corporation, but some states still ask for at least three different people. Some states may ask you have two or three directors if you have more than one person as shareholders of the corporation.

This is the reason you should ask for more than one person as director when you incorporate. If you have two or three directors, there are places to list each list their names on the form.

What is a Federal Employer Identification Number ?
A Federal Employer Identification Number is like a social security number for a corporation. A Federal Employer Identification number is essential to open a bank account, hire employees, tax identification and necessary to put on correspondence with the state.

What is a Registered Agent and What Do They Do?
All states require that your corporation have someone in the state who is the registered agent. You can hire someone to be your registered agent or you can be one yourself for your company.

A registered agent receives mail for your corporation and is a authorized to be an agent for process. Process is the legal term for any type of legal paper that can be served upon you. It is not only for when your company is being sued. For example, your company can receive a subpoena about an employee (or an employee’s spouse in a divorce action) for wages information. You can not use post office boxes as your address. The reason for this is that process (legal papers) has to be delivered personally (in most cases) by a process server, and not just mailed. Additionally the state sends additional information such as tax and franchise fee notices to the registered agent.

All states require that someone inside the state be a registered agent. If you are incorporating in the state your company will be in, (which I recommend), then you or another officer can be the agent. Some corporations do not want to deal with possible potential problems in having to receive process and so they appoint someone else to be the registered agent, even if they are in the state. You can change who is the agent usually by filing a "Change of Agent" application with the state along with a small state fee.

How Many Shares of Stock Can My Corporation Have?
Each certificate can represent more than one share of stock. A certificate can be one, one hundred or even a fraction of one share. So if your company has 200 shares of stock, it can divide the shares up among three shareholders as 66 2/3 shares each. A company can always file to add more shares as needed, for a fee to the state.

My State? Delaware? Where Should I Form My Corporation?
You may have heard that there are advantages of incorporating in Delaware, or Nevada or even out of the country. Some states early in the century had very strict laws for forming corporations and so large corporations formed in Delaware which had more liberal laws, and a greater amount of corporation precedent. However most states today, have made their laws friendly for corporations, in order to attract new business and there are other very good reasons to incorporate in your home state. The main reason for not incorporating in a state where you don’t have your business is that you will still have to register in your home state anyway as doing business as a "foreign" corporation. "Foreign" in this case, is any corporation formed in a state other than the one where you do business.

You will also still have to register in your home state anyway to conduct business and open bank accounts. Plus you will pay duplicate tax franchise fees into two states! You will almost certainly pay higher accounting fees and you will have to pay for someone to be your corporate agent in another state and you will be regulated by the laws of more than one state. That’s why large companies keep lawyers and staff in Delaware or South Dakota.

Secondly, should someone sue your company you will have to hire a lawyer to defend yourself and your company in the separate state where the corporation is set up, even if the only contact with the state was incorporating. And, should you want to take someone to court, you still have to be register the corporation in your state first.

Thirdly, you are subject to the laws of your home state anyway. The liability, tax and the reporting requirements are the same whether you form in Delaware or Nevada. And unless you are ready to open business in many states and hire staff and lawyers all over the country, the prudent and common-sense thing to do is incorporate in your home state.

What is the Down Side of Incorporation?
There are two main disadvantages for incorporation. The first is that it is more slightly more expensive to form than a partnership or an individual proprietorship. Then, a corporation continues to cost money each year for yearly state fees. Secondly, a corporation requires more record keeping, than other type of business entities.

What is The Corporate Book?
Every new corporation needs a corporate book that it keeps all its corporate records. It is ususally possible to obtain and utilize a "Corporation Kit" to start your corporation. The kit usually includes a metal seal embosser, 20 stock certificates with your company name printed on each certificate, sample minutes and by-laws, tax option for you to review, transfer ledger to keep track of who owns shares in the corporation, initial by-laws appointing the first directors of the corporation, a record of all state fees paid, and certificate or articles of incorporation which are filed with the state.

Do I Need An Attorney?
Theoretically, you may not need an attorney to form a corporation. For example, you can work through the process yourself, or use a CPA, or even incorporate by yourself on-line. However, starting a corporation is a legal event which may trigger personal liabilities such as tax liability. You may want to consult an attorney for your state's post-formation requirements.

Boyd W. Shepherd is licensed to practice law and dentistry in the state of Texas, and is a member of the GHDS, TDA, and ADA.