When it comes to establishing a legal structure for your business, you have a variety of options. From an LLC to an S Corp to a C Corp, which option is best for you?
To help you determine if forming a corporation is right for you, and to help with which structure is best suited for your business, we broke down the different types of corporation, as well and the advantages and disadvantages.
Take your time reading through this information because by the end of the article you’ll know how to determine your business structure and which corporation makes sense for you.
What is a Corporation?
A corporation is a legal entity that is separate and distinct from its owners. Corporations enjoy most of the rights and responsibilities that individuals possess: they can enter contracts, loan and borrow money, sue and be sued, hire employees, own assets, and pay taxes.
This entity is a more formal business structure, therefore has more legal requirements that are pertinent to your business success.
How Corporations Work in Texas
To protect themselves from liability, business owners will form a corporation or a limited liability company (LLC). But why choose a corporation over an LLC?
LLCs and corporations both provide business owners with the same type of liability protection. This means owners are generally not personally responsible for business obligations. The difference is that the owners of a corporation are shareholders – not just members.
The corporation issues shares, and each shareholder owns the number of shares that corresponds to their percentage of ownership. For example, if the corporation issues 1,000 shares and you own half the company, you’ll have 500 shares. When you plan to involve outside investors and provide company shares to employees, it’s best to form your business as a corporation from the very beginning.
Because more people and moving parts are often involved in the startup of a corporation, forming one is more time-consuming and costly. Is it not required to have a business lawyer help you with the process, but it is highly advised.
You want to ensure that shareholders are fully protected by any debts or lawsuits incurred by the company. A well-written, properly filed contract by a business lawyer ensures your legal rights – both personally and professionally- are protected with every business transaction. Plus, lawyers can help you stay in compliance with the law, stay ahead of the competition, stay in good standing with regulators, and protect your rights and income.
How to Form a Corporation in Texas
When you choose to form a corporation, you must take many the necessary steps to ensure it’s properly formed. Depending on which state you live and operate in, you may not have to take all the steps mentioned below.
Keep in mind that corporations have a rather stringent management structure and some of these steps cannot be skipped. For example, corporations must have a board of directors that oversees big issues and officers who run the company’s day-to-day affairs. They’re also required to hold annual shareholder meetings and must make annual reports.
Step 1: Choose a Corporate Name
You’ll check for business name availability at the Texas Secretary of State SOS Direct website. You’ll want to add one of the following:
- Incorporated or Inc.
- Corporation or Corp.
- Company or Co.
- Limited or Ltd.
Step 2:File Certificate of Formation
Filing a Certificate of Formation with the Texas Secretary of State is when your corporation is “legal.” The certificate must include information like:
- Corporate name
- Name and address of the registered agent
- Name and address of the initial directors
- Number of shares the corporation is authorized to issue
- Name and address of the organizer
- Effective date of the certificate
Step 3: Appoint a Registered Agent
The registered agent must have a physical street address in Texas and agree to accept service of process on behalf of your corporation.
Step 4: Prepare Corporate Bylaws
Bylaws are not filed with the state and you’re not legally required to have them. However, they’re great to have internally to help set the rules for operating your corporation.
Step 5: Appoint Directors and Hold First Meeting
The person who signed the articles must appoint a “board of directors” for a meeting of shareholders. This meeting is where you appoint corporate officers, adopt bylaws, select a corporate bank, issue stocks, discuss the fiscal year, and more.
Step 6: Issue Shares
This is one of the main reasons people form corporations of LLCs. As a corporation you need to plan which investors to seek out or if you plan to provide company shares to employees.
Step 7: Obtain an EIN and Pay Taxes
As a corporation, you must obtain a federal employer identification number (EIN) on the IRS website. When it comes to paying taxes, remember that Texas imposes franchise taxes on corporations, but only those who earn over $1 million. However, all Texas corporations should register with the Texas Comptroller of Public Accounts and file an annual return.
These are just a few things you need to get started when forming a corporation. There are also tedious aspects like obtaining business permits and licenses, registering with the IRS, opening a corporate bank account, and more.
Different Texas Corporations
Whether you’re a graphic designer or a general contractor who plans to form a corporation, making the wrong decision about which legal arrangement your business will take could cost you a small fortune.
There are 3 types of corporations:
S Corp - A flexible business entity that passes almost all finances through to its shareholders. Because shareholders are responsible for income and loss, S corps avoid the double taxation.
C Corp - The perk associated with forming a C Corp is that there can be any number of shareholders, and they can also be employees of the corporation. However, it’s essential to have a board of directors that make the big decisions.
Non Profit -Similar to a traditional corporation in structure with a board of directors and financial investors, but generates no profits. These corporations are tax exempt and can receive funding through multiple sources such as private donors and grants.
You’ll find that most major corporations are C Corps, while the smaller businesses are S Corps. The big difference is that C corporation shareholders are subject to double taxation. This means the government taxes C Corp income at corporate rates, and then taxes the dividends after the corporation distributes them to the shareholders. Double taxation can often be avoided by spreading profits out to employees as benefits.
You’ll find that most major corporations are C Corps, while the smaller businesses are S Corps. The big difference is that C corporation shareholders are subject to double taxation. This means the government taxes C Corp income at corporate rates, and then taxes the dividends after the corporation distributes them to the shareholders. Double taxation can often be avoided by spreading profits out to employees as benefits.
And as the name implies, a non-profit must generate no profits and be created in support of a specific cause.
If you're passionate about helping others and not the profits you make, a non-profit is the best corporation for you to form. If your future plan is to grow your business and sell it, a C Corp is your best option due to the ability to have multiple shareholders.
Advantages of a Corporation
From protecting your reputation and personal assets to gaining capital, there are several advantages to becoming a corporation. Remember the structure you choose and benefits you receive depends on the specific setup. Here are just a few advantages you will receive:
Separate legal entity - A corporation provides more liability than any other business entity. If a corporation is sued, shareholders are not held personally responsible for the debts.
Limited liability - Shareholders are only liable up to the amount of their investment. Personal assets are protected regardless of what happens with the corporation.
Source of capital - A luxury that corporations have that other business entities do not is the ability to easily raise funds through publicly traded stock. This helps the business in times of need and also helps with growth.
Tax benefits - If you form a S Corp, and have your income distributed appropriately, you are subject to tax benefits. Income incurred by the owner will be taxed under self-employed tax, but the rest will be taxed at its own level.
Ownership transfers - If you’re a shareholder and want to sell your shares, it’s not difficult to transfer ownership through a corporation.
Disadvantages of a Corporation
Just as with every business decision, there are advantages and disadvantages. Here are a few disadvantages to forming a corporation:
Costs - Forming a corporation of any kind is more costly and time-consuming than any other business entity.
Taxation - If you form a C Corp, you are subject to double taxation. This can be avoided, but it’s best to talk with a legal expert to see if this is the best option for you.
Reporting - Corporations must keep (and file) accurate records of income, shares, and other tax documents.
Management - Depending on how you set your corporation up, there may be a management team operating without any real direction from an owner.
Before choosing a business entity, think about where you want your business to be in 5, even 10, years. What are your business goals? The answers to these questions will help you choose the best type of corporation for your company.
Remember, if your business needs change over time, you can always restructure in the future. This is only one area where having an experienced business lawyer comes into play. When making a big decision about the structure of your business, it’s wise to seek guidance from an attorney to determine the best route for you to take.
