Is Incorporation for You?

Incorporation can be a complicated process. So, let’s use a step-by-step process to help you decide if it's right for your home business. On this page we’ll look at:

Basic definitions

The advantages and disadvantages of forming a corporation

Considerations regarding where to form a corporation

14 Steps to incorporating a business

Basic definitions:

Incorporation (abbreviated Inc. in U.S. business names) is the forming of a new corporation.

A corporation is a legal entity or structure created under the authority of the laws of a state. The entity or structure consists of a person or group of persons who become shareholders. The entity's existence is considered separate and distinct from that of its members.

Like a real person, a corporation can:

Sue and also be sued

Enter into contracts

Pay taxes separately from its owners and

Perform other actions necessary to conduct business

If you’re trying to determine whether or not you should incorporate your home business, consider the following advantages and disadvantages.

The advantages and disadvantages of forming a corporation:

Advantages to Incorporating:

Ask yourself the following questions. If you answer yes to any of these questions you might consider incorporating your home business.

Do you need to limit your liability?
A corporation is considered a separate, legal entity. This means that its shareholders have limited liability for the corporation's debts. The personal assets of shareholders are not at risk for satisfying corporate debts or liabilities.

Would you be paying fewer taxes if you incorporated?
Because a corporation is a separate, legal entity, it pays taxes separate and apart from its owners (at least in the typical C corporation). Owners of a corporation only pay taxes on corporate profits paid to them in the form of salaries, bonuses, and dividends. The corporation pays taxes, at the corporate rate, on any profits.

Are you seeking investors?
The built-in stock structure of a corporation makes it attractive to investors.

Are you going to hire employees?
The stock structure allows corporations to attract key and talented employees by offering an ownership interest in the form of stock options or stock.

Would it be advantageous for you to be reimbursed for certain expenses?
A business owner who works in his or her own business may become an employee. He or she would then be eligible for reimbursement or deduction of many types of expenses, including health and life insurance.

Would it be beneficial for you to have a more formal operational structure for you home business?
Corporations have a set management structure. Shareholders are the owners of a corporation, who elect a Board of Directors, which then elects the officers. Other than the election of directors, shareholders do not typically participate in the operations of the corporation.

The Board of Directors is responsible for the management of and exercising the rights and responsibilities of a corporation. The Board sets corporate policy and the strategy for the corporation. The Board elects officers, usually a CEO, vice president, treasurer and secretary, to follow the policies set by the Board and manage the corporation on a day-to-day basis.

Note that in a small corporation, the lines between the shareholders, Board of Directors, and officers tends to blur because the same people may be serving in all capacities.

Do you need your business to continue to exist indefinitely?
Because a corporation is a legal entity, it continues to exist until the shareholders decide to dissolve it or merge with another business.

Do you want other people to own an interest in your business?
Shares of corporations are generally freely transferable because as a separate entity, the existence of a corporation is not dependent upon who the owners or investors are at any one time.

Now, let’s look at several disadvantages to forming a corporation.

Disadvantages to Incorporating:

Can you afford to incorporate?
It costs money to incorporate. There are typically four types of fees: a fee to file the articles of incorporation with the secretary of state; a first year franchise tax prepayment; fees for various governmental filings; and attorney fees.

However, more and more people are choosing to incorporate online without the use of an attorney, sometime for as little as $99.

Do you have the time to go through the required formalities?
In order to receive the benefits of being a corporation, you must following the proper corporate formalities of organizing and running a corporation.

Can you keep up with all of the required paperwork?
Reports and tax returns must be compiled and filed on time. Business bank accounts and records must be maintained and kept separate from personal accounts and assets. Records must be kept of corporate actions, including meetings of shareholders and Board of Directors. Licenses must also be maintained.

Do you want to disclose names and addresses of your officers and directors?
Most states do not require that names of shareholders be a matter of public record. However, many states require that the names and addresses of corporate officers and directors be listed on one or more documents filed with the Secretary of State.

Would you want to be able to dissolve your business easily?
Corporations have a perpetual existence. Therefore, states provide a mechanism for dissolving a corporation and liquidating its assets. Meaning, dissolution of a corporation does not happen automatically.

A corporation can be dissolved voluntarily or involuntarily. A corporation's officers and directors are responsible for dissolving the corporation, including gathering corporate assets, paying creditors and outstanding claims, and distributing remaining assets to shareholders.

Are you aware of the potential tax consequences of having a corporation?
C corporations can potentially experience double tax consequences. How? When the company makes its profit, and a second time when dividends are paid to shareholders. However, this does not necessarily apply to S corporations.

Are you thinking that incorporation is for you? If so, now you need to consider where you might incorporate your business.

Considerations regarding where to incorporate a business:

Because laws governing corporations differ from state-to-state, many people wonder, “Where should I incorporate?"

The simple answer for most people is: incorporate in the state in which you intend to conduct the majority of business. Meaning, if you intend to do business in only one state, you should incorporate in that state.

Do you think you might benefit by incorporating in a state other than where you reside? If so, take the following into consideration:

Determine the tax rate for the state(s) in which you are considering incorporating.

What are the comparative costs of incorporation in a particular state versus the costs of registering to do business as a foreign corporation in that state? Note that a corporation doing business in a state other than its state of incorporation is considered a foreign corporation.

Also note that if you incorporate in one state and end up conducting most of your business in a different state, you will have to qualify to do business in that other state, which will involve more fees and costs, more filing requirements, and more paperwork.

But, if your business actually conducts business in more than one state, or if it is a large, publicly held corporation, it can be worth the additional cost and time to incorporate in one state but operate in another state or states.

What are the corporate laws of the state with regard to the rights and responsibilities of corporate shareholders, officer, and directors?

What are the corporate laws of the state regarding the rights of creditors?

Here is some history that might be helpful to know:

When states first began enacting corporation laws, several states (New Jersey, Delaware, Maine, Arizona, and a few others) enacted laws to attract businesses to incorporate in their states, even though the corporations would do business in other states.

Today, Delaware is the clear winner when it comes to attracting people to incorporate their businesses. Close to one-half of all corporations listed on the New York Stock Exchange are incorporated in Delaware. This is despite the fact that most of those corporations have their principal places of business elsewhere.

So, do your homework before you decide whether or not you’re going to incorporate your home business.

If you decide to incorporate your home business, follow the below 14 steps.

14 steps to incorporating a business:

1. Choose a corporate name.

Many names are already taken and some names have trademark issues associated with them. Check with your Secretary of State to see if the name you’ve chosen is available. Also conduct a search on the internet and a trademark search online to make sure no one is already using the name.

2. Decide in which state to incorporate.

See the above section “Considerations regarding where to incorporate a business” on this page.

3. Prepare the incorporation documents that you will be filing:

These documents can include the Certificate of Incorporation, the Bylaws, the Resolutions of the Board of Directors, the Stockholder Resolutions, the Stock Ledger, Stock Certificates, and more.

The Secretary of State is the official who is responsible for handling each state's business filings. The office of the Secretary of State is where you file the documents and paperwork, and pay fees to create, manage, and dissolve a corporation. All states provide the necessary information for incorporating via online. So, visit your Secretary of State website.

4. File the Certificate of Incorporation with the Secretary of State:

Also known as the Articles of Incorporation, you must file this to officially start your corporation.

5. Determine the right capitalization for the corporation:

Consider the capital needs of the company through a well thought out business plan and financial projections.

6. Issue stock to the shareholders and comply with securities laws:

When you sell stock to shareholders, you have to comply with state and federal securities laws. Use a good corporate lawyer.

7. Will you have more than one shareholder?

If so, think about whether you should have a Shareholder Agreement or a Buy-Sell Agreement. These types of agreements provide what the shareholders are required to do for the business and for rights of first refusal on transfer of their shares.

8. Make sure you have a Corporate Minutes Book:

Set-up a Corporate Minutes Book to keep records of corporate actions such as consents of the Board of Directors and shareholders.

9. Elect the Officers and Directors of the Corporation.

10. Obtain your state and Federal Tax ID number. The form for your federal tax ID is available on the IRS Web site.

11. Determine if you need any special licenses for your business on the state, federal, or local levels.

12. Set up a corporate bank account, separate from any of your personal bank accounts and records.

13. Make sure that you have all the proper forms and agreements for any employees you plan to hire. Use your local government’s labor relations department as a resource. Avoid cutting corners here – you do not want to end up in a labor dispute.

14. Do you want to be an S corporation? S corporations have certain tax advantages. However, you have to follow certain rules and file an election with the IRS.

Do you need additional information? Try accessing the incorporation section on Wikipedia’s on line free encyclopedia. Or contact me. – I am here to help.

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