Starting a corporation can offer significant advantages to business owners. Learn about different types of corporations and how to incorporate your business.
Jan 17, 2024
Starting a corporation is a significant milestone for any business owner, regardless of the size of your operation. A corporation provides a formal structure that establishes your business as a legal entity separate from yourself and any cofounders, and it also offers various other advantages. Here’s more on what a corporation is, the steps to launch one, and the benefits (and drawbacks) of adopting a corporate business structure.
A corporation is a legal entity owned by one or more individuals, institutions, or even other companies. These owners are known as shareholders. The corporation is distinct from its owners and has its own legal rights and obligations. One of the defining characteristics of a corporation is the provision of limited liability, meaning shareholders’ personal assets are generally protected from the corporation’s debts and legal liabilities. A corporation typically enjoys an indefinite lifespan, which only ends when it’s formally dissolved.
The three types of corporations typically used by business owners in the US are the C corporation (C corp), the S corporation (S corp), and the B corporation (B corp). Here’s how they differ:
A C corporation, often known as a C corp, is recognized under subchapter C of the Internal Revenue Code and is the most common type of US corporate entity. Like other corporations, it’s characterized by limited personal liability for shareholders.
C corps have a flexible ownership structure with the ability to issue and sell shares of stock, allowing for a virtually unlimited number of shareholders. The governance of a C corp involves shareholders electing a board of directors, which in turn appoints corporate officers to manage the company’s day-to-day affairs.
Although C corps have relatively easier access to capital, perpetual existence, and limited liability, they’re subject to what’s known as double taxation; the government imposes separate taxes on both the corporation’s profits and on any income shareholders receive in the form of dividends.
An S corporation, or S corp, is a tax designation granted by the US Internal Revenue Service (IRS), providing certain tax advantages to businesses while maintaining the liability protection inherent in a corporation.
Unlike a C corp, an S corp can avoid double taxation by electing to pass corporate income, losses, deductions, and credits to shareholders for federal tax purposes. This means that S corps are not subject to federal income tax at the corporate level; instead, shareholders report the corporation’s income or losses on their individual tax returns.
Unlike C corps, S corps are limited to a maximum of 100 shareholders, all of whom must be US citizens or US residents. Other corporations, partnerships, institutions, or other non-individuals are barred from holding ownership positions.
The core contrast between an S corp and the more popular C corp lies in the tax treatment and ownership structure. While both provide limited liability for shareholders, S corps offer a more tax-efficient structure for smaller businesses, avoiding the double taxation associated with C corps. However, because S corps have restrictions on the number and type of shareholders they can have, their ability to raise capital by issuing stock is limited, constraining their ability to enjoy the advantages of more diverse ownership.
A benefit corporation, or B corp, is a distinct business entity that combines profit-making with a commitment to social and environmental responsibility. Unlike a traditional C corp, the primary focus of which is to maximize shareholder value, a B corp is legally mandated to consider the impact its business decisions have on a broad range of stakeholders, including employees, surrounding communities, and the environment. The B corp structure is designed to ensure the company strives for positive social and environmental outcomes along with financial success.
To become a certified B corp, your company must meet rigorous standards of social and environmental compliance, transparency, and accountability set by B Lab, a nonprofit organization that reviews potential B corps and awards official certifications to businesses that meet its standards.
Starting any type of corporation involves several crucial steps to ensure legal compliance:
Select a unique and suitable name for your corporation. Ensure it complies with your state of incorporation’s business naming regulations, is available for registration, and doesn’t violate any active trademarks.
Prepare articles of incorporation, a document that outlines the basic details of your corporation, including its name, purpose, and structure. File this document with the appropriate government agency in your state of incorporation—usually the Secretary of State’s office.
Identify and appoint directors to your corporation’s board. These individuals will oversee corporate governance, advocate on behalf of shareholders, and appoint managers to carry out day-to-day operations.
Develop corporate bylaws that outline the internal rules and regulations governing your corporation. This document typically covers topics like the schedule and protocols for shareholder meetings, the responsibilities of directors, and the distribution of profits.
If your board of corporation directors is assembled at this point, they can (and should) participate in drafting and approving these foundational rules.
Conduct the first board of directors meeting to discuss and approve important matters, including adopting bylaws, appointment of officers, and issuance of stock.
Allocate and issue stock certificates to the initial shareholders. These represent their ownership interests in your corporation.
Apply for an employer identification number (EIN) with the IRS. This unique identifier—like a Social Security number for businesses—is necessary to pay taxes and is used when opening a business bank account.
Establish business bank accounts for your corporation. This is critical for maintaining financial transparency and avoiding intermingling personal finances with your corporation’s assets.
Obtain the necessary business permits and business licenses to operate legally in your jurisdiction—at the state, county, and municipal levels. Compliance with local regulations is required for avoiding legal complications and interruptions to your corporation’s business.
Designate a registered agent—a person or organization that typically has a physical address in the state of incorporation. In all 50 states, registered agents must be open and available to receive corporate and legal documents and official and government correspondences during regular business hours.
Arguably, a corporation’s primary advantage is the limited liability protection it provides shareholders. In the event a business defaults on debt or receives a legal judgment for damages, shareholders’ personal assets are generally protected. This limits the financial risk to the amount a shareholder has invested in the corporation should the business fail and enter liquidation.
Corporations can raise capital by issuing shares to investors. This makes it easier to attract investors and expand the business compared to other business structures.
A corporation is a legal entity separate from its owners, allowing the corporation to enter into contracts, own assets, and incur debts in its own name, providing autonomy and legal protection.
A significant drawback of a corporate structure is the potential for double taxation, where business profits are taxed at the corporate level, and once more when dividends are distributed to shareholders and reported on personal income tax returns.
If you choose to register your business as an S corp, however, you can avoid double taxation by passing all earnings, losses, deductions, and credits through to shareholders for taxation at the personal level.
Depending on where you incorporate your business, your corporation may also be subject to certain state or local corporate income taxes and fees, such as those associated with filing a required annual report.
The process of starting and maintaining a corporation involves significant paperwork, adherence to regulations, and formalities such as regular board and annual shareholder meetings. This complexity can pose a disadvantage to small businesses or those with otherwise limited resources.
Forming a corporation (and running one) can result in higher costs than other business structures. Filing fees, legal expenses, and regular compliance requirements contribute to the financial burden, especially for small business owners.
The cost to start your own corporation varies significantly depending on many factors, including your state of incorporation, the type of corporation you form, the number of shareholders, and whether you’ve used the services of a business attorney or tax professional. These can range from a few hundred to several thousand dollars.
To start a corporation, you typically need a unique business name, articles of incorporation, corporate bylaws, information about initial directors and shareholders, and the funds to fulfill all legal and filing requirements.
Yes, an individual can start their own corporation as the sole shareholder, director, and officer, taking on multiple roles within the company.
