A guide to incorporating your business

Business entity types: Advantages and disadvantages

Sole proprietorship

The sole proprietorship is the simplest business form and not a legal entity. It is the easiest type of business to establish — no state filing or agreement with other owners is required. It is simply an enterprise owned and operated by an individual.

By default, once an individual starts selling goods or services, he or she has created a sole proprietorship. A sole proprietorship is not legally separate from its owner. The law does not distinguish between the owner’s personal assets and the business’ obligations. In fact, a sole proprietor’s assets can be (and often are) used to satisfy the debts and liabilities of the business. Remember: businesses end all the time. If they end with debts and liabilities, it can become a nightmare for a business owner who operates as a sole proprietor.

Advantages

• The owner can establish a sole proprietorship instantly, easily, and inexpensively.
• No state paperwork is required for creation.
• No separate tax filing is required. Profits or losses are reported on the owner’s tax return.
• A sole proprietor need not pay unemployment tax on himself or herself (but must pay employee unemployment tax).
• Few, if any, ongoing formalities.

Disadvantages

• The owner is subject to unlimited personal liability for business debts, losses, and liabilities.
• Obtaining capital, such as a bank loan, can be more difficult. Lenders often require a more formal entity structure.
• Sole proprietorships rarely survive an owner’s death or incapacity, so they do not retain value.
• Sole proprietorships by definition can only have one owner.

General partnership

A general partnership is the simplest type of partnership and is created automatically when two or more persons engage in a business enterprise for profit.

By default, a business that begins with a verbal agreement or handshake is considered a general partnership. All partners share in both the day-to-day management and business profits. A formal, written partnership agreement that sets forth all the partners’ rights and responsibilities is highly recommended; oral agreements are fertile ground for disputes.

A general partnership offers owners no liability protection — partners are all liable for business debts and obligations, and their personal assets can be used to satisfy those debts.

Advantages

• Owners can start partnerships relatively easily and inexpensively.
• No state paperwork is required for creation.
• Most states do not impose a fee for the privilege of existing.

Disadvantages

• All owners are subject to unlimited personal liability for business debts, losses, and liabilities.
• Individual partners bear responsibility for the actions of other partners.
• Obtaining capital, such as a bank loan, can be more difficult, as lenders often require a more formal entity structure.
• Poorly organized partnerships and oral partnerships can lead to disputes among owners.

Limited partnership

A limited partnership (LP) is owned by two classes of partners: general and limited. General partners manage the enterprise and are personally liable for its debts. Limited partners contribute capital and share profits, but typically do not participate in management. Limited partners also incur no personal liability for partnership debts beyond their capital contributions. At least one partner must be a general partner with unlimited liability, and one must be a limited partner whose liability is limited to the amount of his or her investment. Limited partners enjoy liability protection much like a corporation’s shareholders or an LLC’s members.

An LP allows for pass-through taxation, as income is not taxed at the business level. An informational tax return is filed, but profits or losses are reported on the partners’ personal tax returns and any tax due is paid at the individual level. LPs are especially appealing to businesses focused on a single, limited-term project (such as real estate or the film industry). LPs can be used as a form of estate planning in that parents can retain control of their business while transferring shares to their children.

An LP is a statutory entity. To form an LP, a formation document (typically called a Certificate of Limited Partnership) must be filed with the home state’s business entity filing office (Secretary of State or similar office) along with the filing fee. They are also required to appoint and continually maintain a registered agent (agent for service of process).

Advantages

• LPs enjoy pass-through taxation.
• Limited partners are not held personally responsible for business debts and liabilities.
• General partner(s) have full control over all business decisions.
• General partners have flexibility in how they manage the partnership with few formal requirements and annual paperwork.
• Some states authorize limited liability limited partnerships (LLLPs) which are limited partnerships in which the general partners have limited liability.

Disadvantages

• The general partner(s) face unlimited liability.
• Limited partners are prohibited from participating in business management.
• Ongoing compliance requirements of the state LP law, such as having to file annual reports.
• If the LP transacts business in states other than the formation state, it will have to qualify to do business in those “foreign” states.

Limited liability partnership

A limited liability partnership (LLP) is a special kind of general partnership. LLP partners participate in the management of the business, as in regular general partnerships, but the personal assets of the partners typically cannot be used to satisfy business debts and liabilities. LLP partners may also enjoy personal liability protection from the acts of other partners (but each partner remains liable for his or her own actions). State laws may require LLPs to maintain insurance policies or cash reserves to pay claims brought against the LLP.

The LLP is appealing to licensed professionals — such as accountants, attorneys, and architects — who are accustomed to operating as partnerships. In fact, in some states only licensed professionals can form LLPs. It’s also an option when professionals are prohibited from operating under other business forms, such as LLCs. An LLP also allows for pass-through taxation, as its income is not taxed at the entity level. An informational tax return is filed, but profits or losses are reported on the partners’ personal tax returns and any tax due is paid at the individual level.

To form an LLP, a document (referred to, among other names, as a Statement of LLP Registration) is filed with the home state’s business entity filing office (Secretary of State or similar office) along with the filing fee. An LLP is also required to appoint and continually maintain a registered agent (agent for service of process).

Advantages

• LLPs enjoy pass-through taxation.
• All partners are not held personally responsible for business debts and liabilities.
• Partners have flexibility in how they manage the company with few formal requirements and annual paperwork.
• The LLP form may be the only choice for a professional services business that wishes to have pass-through taxation in states that do not allow limited liability companies to be formed to perform professional services.

Disadvantages

• Ongoing compliance requirements, such as the need to file annual reports.
• If the LLP transacts business in states other than the state in which it is registered, it will have to qualify to do business in those “foreign” states.

C corporation

The corporation is the oldest form of statutory business structure. Although more LLCs are formed these days than corporations, corporations are still popular.

A corporation is a separate legal entity owned by its shareholders, thereby protecting owners from personal liability for corporate debts and obligations. The corporation is liable for its own debts and obligations.

Management of a corporation is governed by the state of incorporation’s corporation law, as well as the corporation’s Articles of Incorporation and bylaws. The statute will require the corporation’s management to observe particular formalities in its operation and administration. For example, management decisions must often be made by formal vote and recorded in corporate minutes. Director and shareholder meetings must be properly noticed and documented.

Corporations must also meet annual reporting requirements and pay ongoing fees in their state of incorporation and in foreign states where they are registered to transact business. They are also required to appoint and continually maintain a registered agent (agent for service of process).

Taxation is a significant consideration when choosing a business entity type. For income tax purposes (and income tax purposes only) there are two types of corporations — C corporations and S corporations. A C corporation (so named because it is taxed under Subchapter C of the Internal Revenue Code) is taxed as a separate legal entity (i.e., no pass-through taxation as with a partnership). A corporate income tax return is filed and taxes are paid on the corporation’s profits. If the corporation distributes profits to the shareholders in the form of dividends, shareholders pay income tax on those distributions. This creates a double taxation of corporate profits.

You don’t create a C corporation. You create a corporation. As with any business entity type that offers liability protection to owners, a corporation must be created by filing a formation document with the state’s business entity filing office, such as the Secretary of State or similar office. Articles of Incorporation (sometimes called a Certificate of Incorporation) in the appropriate state must be filed and filing fees paid. By default, all corporations are taxed as C corporations. So nothing has to be filed with the IRS for a corporation to be taxed as a C corporation.

Advantages

• Shareholders (owners) are not personally responsible for business debts and liabilities.
• C corporations can have an unlimited number of shareholders (as opposed to S corporations).
• Ownership is easily transferable through the sale of stock.
• Corporations have unlimited life, extending beyond owner illness or death.
• Some business expenses may be tax deductible.
• Additional capital can be raised by selling shares of corporate stock.

Disadvantages

• C corporations incur double taxation on corporate profits.
• Corporations are more expensive to form than sole proprietorships and partnerships.
• Corporations face ongoing state-imposed filing requirements and fees.
• Corporations face ongoing formalities, such as holding and properly documenting annual meetings of directors and shareholders.
• If the corporation does business in states other than the state of incorporation it will have to qualify to do business in those “foreign” states.

S corporation

The other type of corporation for income tax purposes is an S corporation (so-called because it is taxed under Subchapter S of the Internal Revenue Code). S corporations have pass-through taxation — thereby sidestepping the double taxation of corporate profits borne by C corporations.

Income taxation is the only distinction between C and S corporations. They are identical under state corporation laws. All corporations, whether taxed as C corporations or S corporations are subject to the same statutory requirements regarding management formalities and ongoing compliance requirements.

S corporations file an informational tax return (much like a partnership) but pay no tax at the business entity level. Corporate profit or loss is reported on the shareholders’ personal tax returns, and any tax due is paid at the individual level.

You don’t create an S corporation. You create a corporation, which is done by filing a document generally called Articles of Incorporation (sometimes called a Certificate of Incorporation) in the appropriate state. Then, in order to be taxed as an S corporation you must file Form 2553 with the IRS to elect S corporation status.

Advantages

• S corporations enjoy pass-through taxation.
• Shareholders are not personally responsible for business debts and liabilities.
• S corporations have unlimited life extending beyond owner illness or death.
• Additional capital can be raised by selling shares of the corporation’s stock. (However, there are restrictions imposed by the IRS on who can be a shareholder and on how many shareholders an S corporation can have.)

Disadvantages

• The IRS imposes restrictions on S corporation shareholders. They must number 100 or fewer; be individuals, estates, or certain qualified trusts; and cannot be non-resident aliens.
• Another IRS restriction is that S corporations can have only one class of stock (disregarding voting rights).
• The IRS also requires that all shareholders must consent in writing to the S corporation election.
• Corporations are more expensive to form than sole proprietorships and general partnerships, and face ongoing, state-imposed filing requirements, and fees.
• A few states’ tax laws require a state-level filing with the state’s tax department for the entity’s S corporation status to be recognized.
• Corporations face ongoing corporate formalities, such as holding and properly documenting annual director and shareholder meetings.
• Corporations face ongoing compliance requirements like filing annual reports and paying franchise taxes.
• If the corporation does business in states other than the state of incorporation it will have to qualify to do business in those “foreign” states.

Nonprofit corporation

A nonprofit corporation is a corporation formed for a purpose other than earning a profit. Nonprofits are authorized by different state statutes than standard for-profit corporations, but the incorporation process is similar. Nonprofit organizers must file nonprofit Articles of Incorporation or a Certificate of Incorporation with their home state’s business entity filing office (Secretary of State or similar office) and pay a filing fee.

Like for-profit corporations, nonprofits provide limited liability protection. Although they do not have shareholders, the personal assets of directors and officers cannot be used to satisfy the nonprofit’s debts and liabilities.

Many nonprofit corporations seek tax-exempt status. To obtain tax-exempt status, nonprofits must apply at the federal and state (if applicable) level — it is not automatically granted when the nonprofit is incorporated.

For federal tax-exempt status, a nonprofit must file Form 1023 with the IRS. For state requirements, it is best to contact the department responsible for taxation in your state of incorporation to determine whether a separate state-level tax-exemption filing is required.

The IRS code contains many different classifications of nonprofits. The most common type of tax-exempt nonprofit is the 501(c)(3). These nonprofits are generally organized and operated for religious, educational, charitable, scientific, or literary reasons; testing for public safety; fostering of national or international amateur sports; or for the prevention of cruelty to animals or children. Nonprofits may also be formed for other purposes. For example, 501(c)(6) nonprofits include business leagues and chambers of commerce. Real estate boards are classified as Section 501(c)(6) nonprofits, and a cooperative hospital service organization is classified as a Section 501(e) nonprofit.

Advantages

• Nonprofits can apply for both federal and state tax-exempt status.
• Some are eligible for public and private grants, making the obtainment of operating capital easier.
• With 501(c)(3) nonprofits, donations made by individuals to the nonprofit are tax deductible.
• The nonprofit affords limited liability protection to directors and officers.

Disadvantages

• Nonprofits incur formation expenses and face ongoing state filing requirements and fees.
• Nonprofits face ongoing formalities, such as holding and properly documenting regular meetings of directors.
• If the nonprofit corporation does business in states other than the state of incorporation, it will have to qualify to do business in those “foreign” states.

Limited liability company

The limited liability company (LLC) is the most common form of business entity in the United States. It is a hybrid business form, combining the liability protection of a corporation with the tax treatment and ease of administration of a partnership. The LLC is a relatively new form of business organization. The great bulk of laws authorizing LLCs in the United States was passed in the 1980s and 1990s. Many of those original LLC statutes have been updated since then.

LLCs enjoy pass-through taxation — sidestepping the double taxation of company profits borne by C corporations (although LLCs can elect with the IRS to be taxed as a corporation). Multi-owner LLCs file an informational tax return but pay no tax on company profits. The members (owners) report their share of the LLC’s profit or loss on their individual tax returns, and any tax due is paid at the individual level. Single-member LLCs report company profits on Schedule C, and any tax due is also paid at the individual level.

LLCs are created by filing a formation document, typically called Articles of Organization or Certificate of Organization, with the home state’s business entity filing office (Secretary of State or similar office) and paying the required state filing fee.

Advantages

• LLCs enjoy pass-through taxation.
• Members (owners) are not personally liable for business debts and liabilities.
• LLCs have no restrictions on the number of members allowed.
• Members have flexibility in structuring the company management.
• The LLC does not have to comply with as many management formalities as corporations.
• LLCs can choose to be taxed as a pass-through entity (like a partnership or S corporation), a disregarded entity (like a sole proprietorship), or a separate taxable entity (like a C corporation).

Disadvantages

• LLCs are more expensive to form than sole proprietorships and general partnerships.
• Ownership is typically harder to transfer than with a corporation.
• Because the LLC is a newer business type, there is not as much case law precedent to rely on
• LLCs face ongoing compliance requirements like filing annual reports and paying franchise taxes
• If the LLC does business in states other than the state of formation, it will have to qualify to do business in those “foreign” states.

Professional corporation

Professional corporations (PCs) are specialized entities organized and operated solely by licensed professionals such as attorneys, accountants, and doctors. Shareholders (owners) may enjoy personal liability protection from the acts of other shareholders, but each remains liable for his or her own professional misconduct.

State laws may require PCs to maintain insurance policies or cash reserves to pay claims brought against the corporation. PCs are formed in a similar manner to standard corporations by filing formation papers with the appropriate state agency and paying filing fees.

Professional limited liability company

Professional limited liability companies (PLLCs) are specialized entities organized and operated solely by licensed professionals such as attorneys, accountants, and doctors. The members (owners) enjoy personal liability protection from the acts of other members, but each remains liable for his or her own professional misconduct. Not all states recognize the PLLC business type.

State laws may require PLLCs to maintain insurance policies or cash reserves to pay claims brought against the PLLC. PLLCs are formed in a similar manner to standard LLCs by filing formation papers with the appropriate state agency and paying filing fees.

Where to incorporate

Once a business owner has decided to form a corporation or form an LLC, the next step is to choose a state of incorporation (also called your home state or domestic state). You are free to form your business entity in any state, but there are factors to consider when choosing, such as forming in the state where the business is located versus another state, state statutes, and state taxation requirements.

Incorporating in the state where your business is located vs. another state

Many business owners forming a corporation or LLC choose the state where their business is physically located. Corporations and LLCs must pay state filing fees at the time of formation, and are also subject to ongoing requirements and fees.

If the company is incorporated in one state but transacts business primarily in another state, it may need to “foreign qualify” in the state where it’s transacting business. Foreign qualification authorizes a corporation or LLC to transact business in a state other than the state of incorporation.

To foreign qualify, the proper document, usually called an Application for Certificate of Authority, must be completed and filed, and additional state filing fees paid. A company is subject to ongoing requirements and fees both in its state of incorporation and also in the state(s) of qualification.

What constitutes transacting business varies by state. Common factors are whether the company has a physical facility, employees, or a bank account in that state. To learn whether your company may need to foreign qualify, talk with an attorney.

Points to consider:

• State filing fees for forming a corporation or LLC in each state under consideration.
• State filing fees to register to transact business (foreign qualify) outside your home state.
• Ongoing fees imposed on corporations and LLCs by each state under consideration.
• Ongoing fees imposed on foreign-qualified corporations and LLCs by the state(s) of qualification.

State statutes and taxation requirements

When evaluating states for incorporation, be sure to research each state’s corporation and LLC statutes. For example, the corporation statute is one reason why Delaware is such a common and popular choice for publicly held and other large corporations. But that same law may not be as beneficial to corporations with only one or a few shareholders (owners).

Business owners should also understand how corporations and LLCs are taxed by each state under consideration and the taxation requirements for foreign-qualified corporations and LLCs in the state(s) of qualification. Consider the following:

• Does a state impose an income tax on corporations and LLCs?
• Does the state impose a minimum tax or a franchise tax?
• Try calculating your company’s projected revenue for its first years of existence and then evaluate the states in terms of the amount of taxes your company would be required to pay.

Delaware

Why has Delaware been one of America’s most popular corporate and LLC destinations? More than 50 percent of all U.S. publicly-traded companies and 60 percent of Fortune 500 companies call Delaware home. But these same advantages may not always apply to smaller businesses. For questions on which state is best for the formation of your business, talk with an attorney or accountant.

Common advantages of forming in Delaware

• Delaware’s corporation and LLC laws are very flexible.
• Delaware’s legislature reviews and updates the corporation and LLC laws every year.
• Delaware has a specialized court that hears cases interpreting the corporation and LLC laws and that decides cases involving management and owner rights and liabilities.
• The filing office is considered modern and helpful.
• There is no state corporate income tax for corporations and LLCs that are formed in Delaware but do not transact business there. (There is a franchise tax, however.)
• One person can hold multiple officer positions and serve as the sole director of the corporation or sole member/ manager of the LLC.
• Shareholders, directors, and officers of a corporation and members or managers of an LLC need not be residents of Delaware.
• Shares of stock owned by persons outside of Delaware are not subject to Delaware taxes.

While incorporating in Delaware holds potential advantages, one disadvantage is that if you operate your business outside of Delaware, you need to “foreign qualify” your business in that state. Foreign qualification is the process of registering a company to transact business in states other than its state of incorporation. When you foreign qualify your company, you must file paperwork with the states in which you’ll be transacting business and pay the necessary filing fees. You also have to appoint and maintain a registered agent.

You will also be subject to ongoing filings and fees (such as annual reports and/or franchise taxes) in your state of incorporation and state(s) of qualification.

The incorporation process

To form a corporation or LLC, a formation document must be filed with the appropriate state agency, usually the Secretary of State, and filing fees paid. This section describes the process typically required to form a corporation or LLC in any state, as well as typical costs and time frames.

Matters of public record and publication requirements

• Information included in the incorporation documents, such as names and addresses, becomes a matter of public record. In the internet age, they are easily searchable by individuals, regulatory and tax authorities, and data mining services.
• Some states require public announcement of new business formations. A state may require that notice of the formation be published in a legal journal or specific, local newspaper for a designated amount of time.

Documentation, fees, and typical time frames

A corporation’s formation document is typically called the Articles of Incorporation or Certificate of Incorporation, depending on the state. An LLC’s formation document is typically called the Articles of Organization or Certificate of Organization. Incorporation documents advise the state and the public of certain details concerning the company. Incorporation documents become a formal record of the corporation’s or LLC’s existence.

State corporation and LLC filing fees range widely. The typical time frame to have incorporation documents approved also varies.

Standard (non-expedited) incorporation filings can take four-to-six weeks to be approved and returned to the business owner. Most states offer expedited filing services for an additional fee, reducing the turnaround time for filing documents to a few days or even a few hours.

Mandatory corporation and LLC disclosures

LLCs and corporations must disclose certain information in their incorporation documents.

The mandatory disclosures vary slightly by state.

Company name

The desired name of the corporation or LLC must be included. For corporations, it must typically include an identifier, such as “corporation”, “incorporated”, “company”, or an abbreviation of those terms. For LLCs, it must typically include the term “limited liability company” or “LLC”. The name cannot already be on the records of the filing office as being the name of another domestic or foreign business entity. Therefore, it is advisable to do a name check to make sure the name is available and then reserve the name before submitting the formation document for filing.

Business purpose

A corporation’s incorporation document typically must include a brief statement of its business purpose declaring the proposed scope of its operations. This may also be required for LLCs in some states. Business purpose clauses are either of two types, general or specific.

General business purpose: Most states allow a general purpose clause indicating that the company is formed to engage in “all lawful business”.

Specific business purpose: Some states require a more complete explanation of exactly what type of business the company will undertake.

Registered agent

Most states require domestic and foreign corporations, nonprofits, LLCs, LPs, and LLPs to name a registered agent (sometimes referred to as a resident agent or agent for service of process), which is the party that receives and forwards important legal documents and official communications on behalf of the company.

The registered agent must have a physical address (no PO boxes) in the state of incorporation, and must be available at that address during normal business hours. Examples of important documents typically delivered to the registered agent include service of process (notice of litigation), subpoenas, garnishments, tax notices, and annual filing notices.

Incorporator

The person or company who files a corporation’s formation document is called an incorporator. The person or company who files an LLC’s formation document is generally called an organizer.

Most states require that the name, signature, and address of the incorporator or organizer be included in the incorporation documents.

Registered agent

The registered agent warrants additional discussion due to the importance of the position and the fact that not all small business owners may be familiar with what a registered agent does.

The majority of states require corporations and LLCs (as well as nonprofits, LLPs, and LPs) to appoint and continually maintain a registered agent in the state where the company is formed. A business owner has the option of serving as the company’s registered agent as long as he or she maintains a physical address in the state in which the corporation or LLC is formed and is available during normal business hours.

There are many corporate service providers who provide business entities with a professional registered agent. While they charge an annual fee, many small business owners find their services advantageous for reasons such as the fact that the registered agent’s name and address are included on the incorporation documents (instead of the owner’s), that it ensures someone is always present during normal business hours to facilitate receipt of documents delivered to the registered agent, and that professional registered agents have expertise in handling these very important and time-sensitive documents.

Many professional registered agents also provide other compliance services that can help small businesses keep track of important corporate information and provide alerts for upcoming compliance events. Some may also assist you with filing your company’s annual report, DBA filings, and business licenses, and monitor the status of your company with your state of incorporation.

Advantages of using a registered agent service provider

Stability: The registered agent address must be kept updated with the state. If a business owner serves as the company’s registered agent and moves, he or she must file an amendment or change of registered address form and pay necessary state filing fees to update the registered agent address on record for the company. Under some state laws, a failure to update the registered address in a timely manner is grounds for administrative dissolution. If a registered agent provider is used and moves, the provider will update the state.

Privacy: The registered agent’s name and address are public information. (In fact, the main purpose of the registered agent requirement is so that the public can know how to contact or serve process on the company). Some business owners want to protect their privacy and not have their addresses disclosed to the public.

Reliability: Registered agent service providers maintain fully staffed offices to receive documents served on them. They treat the receipt of these documents and prompt delivery to you with utmost professionalism.

Compliance assistance: Many corporate service providers not only provide registered agents but offer tools and services to help business owners keep their companies in compliance with both internal formalities and the ongoing filing and fee requirements imposed by the state of incorporation. Companies that do not meet their compliance requirements face the possibility of monetary fines, losing the limited liability protection offered to owners, and/or administrative dissolution of the business by the state.

Disclosure information required for corporations

The information required in corporate formation documents varies from that required for LLCs. The following disclosures are generally required.

Number of authorized shares of stock

Corporations must set forth the number of shares of stock they wish to authorize and the par value, if any, associated with those shares. A corporation need not issue the total number of authorized shares. Some opt to withhold unissued shares in order to add additional owners at a later date or to increase the ownership percentage for a current shareholder.

Share par value

Par value is the minimum stated value of a share of stock. It typically doesn’t correlate to the actual value of a share. Common par values are $0.01, $1, or no par. The actual value is fair market value, or what someone is willing to pay for a share of stock. For public companies, actual value is determined by the price investors are willing to pay for each share on the national exchange. For private companies, the actual value of a share is typically determined by the overall value of the corporation or the book value. It often makes sense to establish a low par value for shares, as a number of states use par value to calculate a corporation’s franchise tax obligations.

Preferred shares

If a corporation plans to authorize both common and preferred shares, this information, along with any information on voting rights, must be included in the Articles of Incorporation.

Preferred shares typically provide those shareholders preferential payments of dividends or distribution of assets should the company end operations. Many small business owners choose to only authorize shares of common stock. For details on preferred shares and voting rights, talk with an attorney.

Directors

Directors are responsible for overseeing and directing corporate affairs, including making major corporate decisions. However, they are not responsible for the daily business activities. They appoint the officers who are responsible.

Initial directors may be named in the Articles of Incorporation, and if so, they will hold an organizational meeting after the Articles are filed to complete the incorporation. Thereafter directors are elected by the shareholders at the annual shareholders’ meeting that all corporations are required by statute to hold.

Officers

Names and addresses of officers are generally not included in the incorporation documents. Officers are responsible for the day-to-day activities of the corporation. Common officer titles include president, vice president, secretary, and treasurer. In most states, one person can fulfill multiple roles.

Disclosure information required for LLCs

The following disclosures are generally required for LLCs.

Management structure

LLCs must typically specify whether the company will be managed by its members (owners) or by managers. When an LLC is managed by members, owners are responsible for the daily business operations.

When managed by appointed managers, it is the managers and not the members who are responsible for the daily operations.

Members/Managers

Some states require the names and addresses of the initial member(s) or manager(s) of the LLC be set forth in the formation documents.

Dissolution date

All states allow (but not all require) the LLC to list a dissolution date in the Articles of Organization, dictating the maximum duration of an LLC’s existence. Every state allows for perpetual existence.

Common information required for nonprofits

A nonprofit corporation’s Articles of Incorporation or Certificate of Incorporation resemble for-profit Articles of Incorporation, but with a few key differences:

• Nonprofits do not issue stock, so the nonprofit Articles of Incorporation will not require information on shares of stock or par value.
• Nonprofits must include very specific and detailed business purpose clauses. This information is used by the state to ensure the company fits within the nonprofit guidelines. It is also evaluated by the IRS if the nonprofit applies for federal tax-exempt status.
• The state-approved Articles of Incorporation must be provided to the IRS when the nonprofit applies for a federal tax-exempt status.

Post-incorporation and compliance requirements

Requirements imposed on corporations and LLCs do not end when incorporation documents are approved by the state — they are ongoing. Owners enjoy certain benefits from corporations and LLCs, and must fulfill responsibilities to maintain those benefits. Failing to follow requirements can result in dire consequences, including the potential loss of the limited liability protection provided to the owners.

Internal requirements

Corporations are required by corporation law to undertake certain ongoing formalities in their internal governance. While LLCs do not face the same statutory requirements, similar steps are recommended and can be required to be taken if so provided in the operating agreement.

The importance of faithfully undertaking and properly documenting each cannot be overstated. Failing to do so can result in disputes over the validity of actions taken. It can also be an indicator that the owner did not respect the corporation or LLC’s separate existence, which can lead to a loss of limited liability protection for the company’s owners if a court decides to “pierce the corporate veil”.

There are many tools available today, specifically geared towards small business owners, to make complying with internal formalities as easy and convenient as possible.

A corporation’s bylaws are second only to its Articles of Incorporation in importance. Bylaws outline the corporation’s internal governance rules, and address a wide range of internal policies and procedures — from establishing a corporation’s fiscal year and what corporate actions require shareholder approval, to outlining how many officers a corporation will have. Bylaws are adopted by a corporation’s directors at their organizational meeting.

Another item often addressed during the organizational meeting is corporate authorization to open a bank account. Some banks require a copy of a directors’ resolution approving the bank account and assigning which officers will have signature authority on it.

Corporate internal requirements

Corporations face the strictest statutory requirements of any business type. The following ongoing steps are required of corporations:

• Create and update bylaws.
• Hold an organizational meeting where bylaws are adopted, officers are appointed, shares of stock are issued to initial shareholders, and initial business decisions or steps (such as authorizing the corporation to open a bank account) are approved. Minutes outlining all actions taken at the organizational meeting should be taken and kept in the company record book.
• Hold an initial meeting of shareholders to approve the incorporation, the initial board of directors, and the steps taken by directors at the organizational meeting. Minutes outlining all actions taken should be taken and kept in the company record book.
• Hold and properly document meetings of directors and shareholders (or actions taken by consent without a meeting if permitted). Every corporation is required by the corporation statute to hold an annual shareholders’ meeting. At their annual meeting, shareholders undertake the renewal of directors’ terms and/or appointment of new directors. They also vote on other matters that are properly raised and can get an update on the status of the corporation from the management.
• Directors make their decisions at duly held and noticed meetings. Minutes outlining all actions taken at the director’s meeting should be taken and kept in the company record book.
• Record changes in company ownership in a stock transfer book or ledger.

Internal LLC recommendations

While LLCs are not required to follow ongoing formalities by the LLC statutes, undertaking the following steps is typically recommended:

• Create and regularly update an operating agreement. An operating agreement is an LLC’s most important document. Some states require LLCs to adopt an operating agreement. Some further require it to be in writing. Regardless of the statutory requirement, it is advisable for all LLCs, even those solely owned, to have a written operating agreement. An LLC’s operating agreement outlines the internal governance of the LLC, the rights, duties, responsibilities, and liabilities of members and managers (if any), and much more.
• Hold an initial meeting of the members or managers to approve the operating agreement, issue membership interest to members, and undertake initial company decisions, such as authorizing the LLC to open a bank account. It is also recommended that the actions taken at this meeting be documented and kept in a company record book.
• Hold and properly document the actions taken at meetings of members or managers.
• Record any changes in ownership (membership) interest in a transfer book or ledger.

External compliance requirements

External (compliance) requirements are imposed by the state corporation and LLC laws on corporations and LLCs. They often include an annual or biennial state filing and payment of a corresponding state fee.

Nearly all corporations and LLCs must file periodic reports with the Secretary of State’s office or the equivalent department. Annual statements are the norm — but some states have relaxed their rules and require only a biennial statement. In either case, states typically impose a fee along with the filing. The fees vary widely by state and by entity type.

Some states also impose a franchise tax — levied for the privilege of existing as a corporation or LLC that is incorporated or registered to transact business in that state. A franchise tax may be based on income, assets, outstanding shares, or a combination. It might also be a flat fee.

The due dates for annual statements and franchise taxes vary by state. Some states connect these dates to the anniversary of the company’s incorporation (or date it registered to transact business in the state, in the case of annual statements and franchise tax imposed on foreign qualified companies). Others set a particular due date for all corporation annual statements and another for all LLCs. Because the periodic filing requirement and annual franchise tax can represent a significant burden and expense, business owners should research these requirements prior to incorporating.

Additional external requirements

Here are some other potential state and federally imposed requirements that may apply to your company:

• Filing a federal income tax return and paying necessary taxes. (Corporations and LLCs taxed under Subchapter C)
• Filing a state income tax return and paying necessary taxes. (Corporations and LLCs taxed under Subchapter C)
• Payroll tax obligations (such as social security, Medicare, and unemployment).
• Property tax obligations.
• State sales and use tax obligations.
• County, city, or municipality tax obligations.
• Obtaining and renewing any necessary federal, state, and/or local business permits and/or licenses.
• Registering assumed names (DBA) if the company will be doing business under a name other than its legal name.

Consequences of non-compliance

Small business owners should be aware that failing to observe internal and external requirements can yield dire consequences, such as having to pay additional fees and penalties, losing good standing status, and loss of the limited liability protection provided to the company’s owners.

A corporation or LLC that does not comply with certain state requirements, such as the annual report or franchise tax requirements, can lose its “good standing” status with the state. Each state has different parameters for what is required before a company falls out of good standing and also how the states handle it. For example, as a first step, many states impose late fees and interest payments on the outstanding annual statement and/ or franchise taxes or fees.

The Secretary of State (or similar office) may refuse to file documents on behalf of corporations or LLCs not in good standing. Banks and lenders also generally require proof of good standing before making loans. And being out of good standing long enough may lead to administrative dissolution of the company by the state. When the state administratively dissolves a corporation or LLC, the corporation or LLC is not allowed to conduct its usual business and must wind up its affairs and eventually liquidate.

If the owners decide they don’t want to wind up and want to continue in business, they may be able to file an application for reinstatement. This requires the payment of all back taxes, filing reports that are due, and paying interest and penalties.

Piercing the corporate veil

Every state corporation and LLC law states that the corporation or LLC has its own separate legal existence and is liable for its own debts and other obligations. They also provide that shareholders and members are not liable for the corporation or LLC’s debts and obligations.

However, while the statutes provide for liability protections, courts (using their equitable powers) can under certain circumstances ignore the corporation or LLC’s separate existence and hold the owners liable for business debts.

The term “piercing the corporate veil” refers to a court’s decision to sidestep statutory liability protection normally afforded by a corporation or LLC and impose personal liability upon the owners. A close corollary rule is the alter ego theory, which essentially says that if the owners disregard the legal separateness of the corporation or LLC, the law will also disregard the corporate or LLC form to protect creditors.

Among the factors courts look at in determining whether the owners have disregarded the legal existence of the corporation or LLC is whether they followed management formalities, such as holding meetings and documenting actions taken, and following statutory compliance requirements. Although other factors typically are more persuasive, such as whether the corporation or LLC was undercapitalized and whether the owners used the company’s assets for personal purposes, it is still helpful if the owners can show they followed external and internal requirements.

Courts have long recognized the distinct legal status of liability-shielding entities. And courts are reluctant to disregard the corporate or LLC status — though they will pierce the corporate (or LLC) veil in appropriate circumstances, particularly when the court believes failing to pierce will result in injustice or unfairness to the plaintiff.

Using an incorporation service provider

Using an attorney to incorporate a business is not a legal requirement. Business owners can use an online incorporation service provider or incorporate on their own directly with the appropriate state agency.

Using an incorporation service provider has become the incorporation method of choice for many small business owners. They are less expensive than using an attorney, and using a service provider is typically less time-consuming and less confusing than preparing and filing one’s own incorporation documents.

Keep in mind, incorporation service providers are not law firms and cannot provide legal advice. They can, however, provide general information on business structures and state requirements, and walk you through the incorporation process step by step.

Benefits of using an incorporation service provider

Save time: When business owners personally prepare and file their formation documents, they often spend more time than anticipated or desired to research state requirements and fees and obtain, complete, and submit appropriate documents.

Save money: Using an attorney or an accountant to prepare and file formation documents is another option. But it can often be quite expensive, particularly for new business owners who need all of their spare capital to start operations. If a business owner needs the advice of an attorney on an entity type or where to incorporate, a provider can still be used for the actual preparation and filing of the incorporation documents. This helps save money, since the owner is only paying the attorney’s hourly fee for advice, and not for time facilitating the incorporation process.

Make incorporation understandable: Many incorporation service providers want to help business owners understand the business type choices available to them, the process of incorporation, and ongoing requirements. Look for a provider with articles and tools to help make learning easy.

Comprehensive offerings: Incorporation service providers typically charge a service fee plus the state filing fee in order to prepare and file your incorporation documents. Many offer additional products and services (often as part of incorporation packages) that business owners typically need when starting and/or incorporating a business. Additionally, many offer filings and other services business owners often need throughout and/or later in the life of their business, such as ongoing compliance assistance, registered agent service, business license, and doing business as (DBA) filings.

Professionalism: When choosing an incorporation service provider, ensure that the company’s contact information and customer service hours are easy to find. Look for customer testimonials and membership seals demonstrating that the company belongs to organizations that promote good business practices. Also, because most incorporation service providers offer online ordering, check for a privacy policy and ensure that the checkout process is secure.

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