Business incorporation is a process in which a business officially registers as a corporation in the state in which it has its main office. Businesses that have incorporated have a different legal status than non-incorporated entities. For example, corporations may pay taxes differently than unincorporated businesses, because a corporation is considered to be an “individual person” under law. The assets and income of a corporation are separated from its owners and investors.
If a business does not register as a corporation, it is considered a sole proprietorship. The assets and liabilities, e.g. debt, of a sole proprietorship are not separate from those of the owner. The owner can be legally responsible for the debts and other obligations of a sole proprietorship. Sole proprietorships still need to have a trade name. Sole proprietorships cannot sell stock and banks are less likely to lend to this form of business entity.
Thus, incorporation may be desirable for some businesses that are seeking various rights and protections under applicable laws. For example, if a business wants to be able to sell stock or attract investment, it might want to incorporate.
However, the incorporation process can sometimes be complex, and may often involve distinct types of legal and business disputes. There are also many different types of corporations each type has different tax obligations and different kinds of protections for the owners. There can also be different filing requirements for establishing each type.
One of the first issues about which colleagues starting a business can disagree is the form of corporation they should have, if they want to operate as a corporation. The types of corporations that are recognized in law vary from state to state, but some common types include:
The C corporation: A C corporation is a business entity that is legally separate from its owners. A C corporation can make a profit, be taxed and be held legally liable. The C corporation structure protects its owners from personal liability for the actions of the corporation. It is, however, the most expensive and complicated to set up and operate. It must keep detailed records, follow certain procedures and processes and provide a certain amount of reporting; C corporations can raise money to fund its operations by issuing stock.
The S corporation: an S corporation is a way to avoid the double taxation that applies to C corporations. A C corporation’s profits are taxed; then when the profits are distributed to shareholders as dividends, they are taxed again. The S corporation structure allows profits (and some losses) to be passed directly to the owner’s personal income without being taxed as corporate profit; not all states tax S corporations in the same way, but most recognize them as does the federal government and tax the shareholders in the same manner as the IRS.
Some states do tax S corporations on profits above a specified limit. Other states do not recognize the S corporation structure, simply treating them as C corporations. S corps must file with the IRS to get S corporation status, a process that is separate from registering with their state.
There are a few special limits on S corporations. They cannot have more than 100 shareholders, and all shareholders must be U.S. citizens. Also they must follow the strict filing and operational processes of a C corporation. As with a C corporation, If a shareholder leaves the company or sells his or her shares, the S corp can continue doing business undisturbed.
The B corporation: A benefit corporation, sometimes called a B corporation, is a for-profit corporation recognized by most U.S. states. There are differences between a B corporation and a C corporation in terms of their purpose, their accountability, and transparency. They are the same, however, in how they are taxed; B corps are supposed to produce some sort of public benefit in addition to a financial profit.
Some states even require them to provide annual benefit reports that show their contribution to the public good.
The Close corporation: Close corporations are similar to B corporations but they have a less traditional corporate structure, including fewer of the formalities that typically govern corporations and apply to smaller companies. Rules vary from state to state, but usually shares cannot be publicly traded. A small group of shareholders can run a close corporation without a board of directors.
The Nonprofit corporation: As its name suggests, a nonprofit corporation is created to engage in charitable work. Because their work benefits the public, nonprofits can be tax-exempt, meaning they do not have to pay either state or federal taxes income taxes on any income it realizes; nonprofits must apply to the IRS to get tax-exempt status. This is a separate process form registering with their state.
Nonprofit corporations must follow organizational rules that are very similar to those that a regular C corporation must follow. They must also follow special rules about what they do with any profits they earn. For example, they cannot distribute profits to members or political campaigns; nonprofits are often called 501(c)(3) corporations; this is a reference to the section of the Internal Revenue Code that is used to grant tax-exempt status.