Part 3: The Standard C – Forming a Corporation
This is part 3 of a 4 part series entitled “What Type of Business Entity should I choose?”. In Parts 1 and 2, respectively, I discussed the various aspects of starting a business as a sole proprietorship and important considerations when forming a business partnership.
In this Part 3, I will explain the different aspects and steps to take when forming a corporation, and why you should consider this option when forming your business entity.
First, let me go back to why individuals decide to operate under the umbrella of a business entity in the first place. People choose the protection of a business entity to avoid their personal assets being exposed to liability. In Texas, only some of your assets are automatically exempt.
At Romano & Sumner, we always strive to make sure our clients are thoroughly educated on all of the options they have available to them. Before you move forward in forming your business entity, you should be aware of the positive and negative impacts that may occur depending on how you choose to form your business. Our recommendations will vary depending on each client’s circumstances. If you have further questions about making this crucial decision in starting your business, please don’t hesitate to contact us.
Corporations aka Corp., The C-Corp, Incorporated, Inc., Company, and Co.
So, what is a corporation?
Let’s begin with a definition of a corporation:
The Corporation is a legal entity – i.e. it is treated like a person. However, because a corporation cannot make decisions, it is run by a board of directors and officers. It is owned by shareholders, who exchange their capital investment for shares of stock. It provides the maximum personal protection available – so long as the corporate formalities are observed, and the directors or officers don’t do anything that would allow someone to “pierce the corporate veil”
I am going to revisit my hero’s from the last section of Part 2 of this series, Clark Kent and Bruce Wayne. Clark and Bruce have a great idea for starting a business called Superheroes, Inc. They have decided that a corporation is the best business entity to form this new endeavor under.
Now, Clark and Bruce are asking the following questions:
What do we need to do to incorporate Superheroes, Inc.?
- Clark and Bruce must first file a Certificate of Formation with the Texas Secretary of State.
- This is similar to Partnership Documents – i.e. registered agent, business purpose, etc. Differences include:
- Listing the initial directors
- List the number of authorized shares and the par value
- Filing fee of $300
- Clark and Bruce must also adopt By-Laws that govern how the Corporation will be run.
- They must have an initial meeting to elect the board of directors and appoint officers.
- They must invest capital in return for shares in the corporation.
What rules or practices are we required to follow to maintain the corporate formalities?
They must have annual meetings for:
- The board of directors and maintain the minutes.
- The Shareholders and maintain the minutes
- They must “Respect the Corporate Form”
- Clark and Bruce cannot co-mingle Superheroes, Inc.’s bank account with their own.
- They cannot pay personal bills from Superheroes, Inc. account.
- They cannot have Superheroes, Inc. buy a new Mercedes or Batmobile for personal use.
Speaking of a Mercedes and Batmobiles, are my assets protected under the corporate business entity?
Yes. As shareholders, Clark and Bruce’s personal assets are protected. If Bruce Wayne is also a director and CEO, then so long as he didn’t use the corporation as an extension of his own will –i.e. paid his cable bill and mortgage using corporate bank accounts–then it will be difficult to “pierce the corporate veil” and get to his personal assets.
What are the Pros vs. Cons of incorporating a business?
- Asset protection
- Transferability – I can easily sell my shares
- Corporate formalities
- Corporations must also pay state franchise tax
- Double Taxation
Remember: the corporation is like a person. Its earnings are taxed and then when dividends are paid, the shareholders pay tax again.
Overall Costs of forming a C-Corp
- Double taxation!
- State Franchise Tax
- Filing Fees
Forming an S-Corporation
Clark Kent and Bruce Wayne are on board with the idea of forming Superheroes, Inc. as a C-Corp. They really like the idea of the protection provided by the C-Corp. However, there is a big problem:
They both hate the idea of double taxation…is there anything our heroes can do?
Yes – Convert the C-Corp into an S-Corp
Now, Clark and Bruce are asking a new set of questions:
How do we form an S-corp?
To convert Superheroes, Inc. into an S-Corp, they must follow this process:
- Go through the steps of forming Superheroes, Inc. as a C-Corp.
- They must file IRS form 2553.
- Upon filing, and acceptance by the IRS Superheroes, Inc. is now an S-Corp. There is no new name or suffix attached. That is it.
What are the requirements to form an S-Corp?
- The C-Corp being converted to an S-Corp must be a domestic corporation.
- The corporation must have only allowable shareholders
- including individuals, certain trust, and estates.
- This may not include partnerships, corporations, or non-resident alien shareholders. (In this scenario, we will assume that Clark Kent is considered a resident of the U.S. and not deal with the complexities of his “Superman” origin story)
- The Corporation can have no more than 100 shareholders
- The Corporation can only have one class of stock
Are there benefits to forming an S-Corp that I should know about?
Yes – the S-Corp can pass along income, losses, deductions, and credits to the shareholders. In an S-Corp, there is no double taxation, and they will still have stronger Asset Protection as a corporation.
Get help with deciding on which business entity to choose when forming your partnership.
Figuring out how and why to form a corporation and whether you should choose the C-Corp option or S-Corp option can be a daunting task. Deciding how you will conduct your business can be the most crucial decision you make in forming a business entity.
If this process of choosing a corporation vs. an LLC seems too daunting to go through on your own, we are happy to help. We thoroughly enjoy helping our clients navigate through the legal aspects of forming and building their businesses. Contact us today and let us know how we can help you.
Modern architecture office building by Powel Pacholec
Batmobile by Nick Traveller
Mercedes… by Robert Basic