C Corporation
A stock corporation is a legal entity separate from its owners who own shares. In a stock corporation, the ownership is divided into shares, and each shareholder's ownership is proportional to the number of shares they hold. The shares represent the ownership interest in the company and entitle the shareholders to certain rights, such as voting rights, dividend payments, and the right to share in the company's profits and assets.
Registration
Corporations must be registered with the state. If planning to operate in 2 or more states you will most likely need to register in each state separately. After the registration EIN must be obtained. The name has to be unique within the state.
Here are the steps for starting a corporation.
Formally register with the secretary of the state by filing Articles of Incorporation: in our states section we'll cover in detail specific requirements and fees each state has for registering a corporation.
Obtain an Employer Identification Number
Write the Bylaws: outlining the internal rules and regulations of the corporation as wells as appointing directors and officers.
Issue stock: after authorizing the number of stocks that can be issued in the articles of incorporation, the corporation can sell ownership to potential shareholders.
Let’s look at each step separately.
Articles of Incorporation
Articles of Incorporation, also known as a Certificate of Incorporation or Corporate Charter, are legal documents that outline the foundational details and structure of a corporation. These documents are filed with the secretary of state's office, to formally establish a corporation as a legal entity and are publicly available
The articles of incorporation typically include essential information such as:
Name: The official name of the corporation, which must be unique and distinguishable from other registered entities.
Registered Agent: The individual or entity responsible for receiving legal documents on behalf of the corporation.
Principal Place of Business: The primary physical location where the corporation conducts its operations.
Purpose of the Corporation: A statement describing the nature of the corporation's business activities or objectives.
Authorized Shares of Stock: The number and type of shares of stock that the corporation is authorized to issue. This outlines the ownership structure of the corporation.
Board of Directors: Information about the initial board of directors, including their names and addresses.
Duration: Specifies whether the corporation's existence is perpetual or has a predetermined termination date.
Bylaws: Although not typically included in the articles of incorporation, a reference to the corporation's bylaws may be included, as they provide further details about the corporation's internal operations and governance.
Incorporators: The names and addresses of the individuals responsible for filing the articles and establishing the corporation.
Articles of Incorporation vary by jurisdiction, and different states may have specific requirements for what information must be included. Filing the articles of incorporation marks the formal creation of the corporation as a distinct legal entity, separate from its founders and shareholders. It grants the corporation certain rights, privileges, and responsibilities under the law, including the ability to enter into contracts, own property, and conduct business activities.
Corporate Bylaws
Corporate bylaws are a set of internal rules, regulations, and procedures that outline how a corporation operates, governs itself, and makes decisions. Bylaws provide a framework for the organization's structure, management, and key operational aspects, ensuring consistency, clarity, and transparency in the corporation's activities. They are created and maintained by the corporation's board of directors and can be amended over time as needed. They are internal and do not need to be filed with a state or federal agencies.
Key components typically addressed in corporate bylaws include:
Corporate Structure: Bylaws outline the hierarchy of corporate governance, including the roles and responsibilities of shareholders, directors, officers, and committees. This helps establish lines of authority and decision-making processes.
Board of Directors: Bylaws define the size of the board, how directors are elected or appointed, their terms of office, and qualifications. They may also detail the board's powers and duties, as well as procedures for removing directors.
Officers: The bylaws outline the roles and responsibilities of corporate officers, such as the CEO, CFO, and Secretary. They may also specify officer appointment procedures and the delegation of authority.
Committees: Bylaws may establish various committees (e.g., audit, compensation, nominating) and define their composition, functions, and powers.
Shares and Stockholders: They address matters related to shares, such as the issuance, transfer, and ownership of shares. Bylaws may also outline procedures for proxy voting and dividend distribution.
Amendments: Procedures for amending the bylaws are typically included, specifying how changes can be proposed, approved, and recorded.
Indemnification: Bylaws may include provisions for indemnifying directors and officers against legal actions or liabilities incurred in the course of their roles.
Shareholder’s Agreement
Shareholders' agreement is a more specific agreement among certain shareholders that addresses their individual rights and relationships. This is an internal document and does not need to be filed with federal or state agencies.
Scope and Purpose: A shareholders' agreement is a private contractual arrangement among specific shareholders of the corporation. It addresses the rights, obligations, and relationships between individual shareholders.
Binding Nature: A shareholders' agreement is a private agreement between the parties who sign it, typically the shareholders who are parties to the agreement. It's not usually filed with regulatory agencies and doesn't govern the corporation as a whole.
Customization: Shareholders' agreements are highly customizable and can address specific issues that are relevant to the parties involved. They allow shareholders to tailor their arrangements to their unique circumstances.
Content: A shareholders' agreement often covers matters such as share transfer restrictions, buy-sell provisions, dispute resolution mechanisms, exit strategies, and other matters relevant to shareholder interactions.
Amendment: Shareholders' agreements can only be amended with the consent of the parties who signed the agreement, in accordance with the terms set out in the agreement itself.
Issue Shares
Issuing stock involves creating and distributing ownership shares of a corporation to investors or individuals who become shareholders. Here's a general overview of the process:
Determine Stock Type and Class: Decide on the types and classes of stock you want to issue. Common stock and preferred stock are the most common types. Preferred stockholders usually have certain privileges over common stockholders, such as priority in dividend payments.
Authorize Shares: The number of shares to be issued needs to be authorized in the company's Articles of Incorporation. This is typically done during the initial incorporation process, but additional shares can be authorized later if needed.
Set Par Value (if applicable): Some jurisdictions require a par value for each share of stock. Par value is a nominal amount assigned to each share, often used for accounting and legal purposes. However, many companies issue "no-par value" shares to avoid complexities.
Board Approval: The board of directors must pass a resolution to approve the issuance of new shares. This resolution specifies the number of shares to be issued, the price (if applicable), and any other relevant terms.
Determine Issue Price: If you're selling the shares at a price higher than the par value (common with common stock), determine the issue price per share. This could be based on the current market value of the company, negotiation with investors, or other factors.
Offer Shares: Offer the newly issued shares to potential investors. This can be done through private negotiations or through public offerings like Initial Public Offerings (IPOs) if the company is going public.
Subscription Agreement: Investors interested in purchasing shares will enter into a subscription agreement. This document outlines the terms and conditions of the share purchase, including the number of shares, price, payment terms, and any restrictions.
Payment: Investors make payments for the shares they're purchasing as per the terms in the subscription agreement. Payment can be in the form of cash, assets, or services, depending on the arrangement.
Issue Stock Certificates or Electronic Records: Once payment is received, the company issues stock certificates to the shareholders as evidence of their ownership. In modern times, electronic records are often used instead of physical certificates.
Recordkeeping and Regulatory Filings: Keep accurate records of all issued shares and their ownership. If required by regulations, file necessary paperwork with regulatory authorities to report the issuance of shares.
Update Shareholder Records: Maintain a shareholder registry that includes the names, addresses, and ownership details of all shareholders. This information may be needed for voting, dividends, and communication.
Taxation
By default, every corporation is taxed by IRS as a C corporation. Unless S corp election was made or a tax exempt status was approved, the corporation must file federal form 1120 by April 15th of the following year. The form consists of 3 main parts:
Profit and Loss
Balance Sheet
Compliance Survey
In the Profit and Loss section business expenses are deducted from the gross profit and the resulting net income is subject to 21% flat corporate tax rate. The tax can later be reduced by various tax credits such as Employee Retention Credit or Research and Development Credit. The net income left after paying tax is called retained earnings. Corporation may choose to distribute it to shareholders or reinvest it in operations.
Corporations must also file tax returns in most states they do business. Typically, a c corporation is only responsible for state tax on the portion of the income that derives from that state. In our states section we'll cover in detail tax rates and filing requirements for each state.
Paying Yourself
There are 3 ways corporation can pay its owners.
Dividends
Reasonable Salary
Stock Buybacks
Dividends
Dividends are not limited to large institutional investors or stockholders alone. Business owners, particularly those who operate as shareholders in their own companies, can pay themselves in the form of dividends as a mean of compensation. The biggest disadvantage of paying oneself in dividends is the double taxation as dividends are paid in after tax money. For instance, c corporation made $100,000 in net profit. $21,000 is paid in federal income tax and the remaining $79,000, distributed in form of dividends is now subject to personal income tax of up to 37% and if the state also has an income tax one can wind up with almost 60% effective tax rate.
Salary
C corporation owners not only may but are required to pay themselves a reasonable salary if they actively participate in the management and running of the company. Once put on payroll the business owner will be hit by Social Security and Medicare taxes, a myriad of other local taxes and payroll processing costs. On the brighter side, all those costs are tax deductible. If the income after all other deductions is $100,000 from which $60,000 is wages, corporation is responsible for approximately $4,500 in payroll taxes and the owner pays another $4,500 in Social Security and Medicare. The remaining net income of the corporation is now $100,000-60,000-4,500 = 35,500. 21% is $7,455. Net profit after tax is $28,045. Now that distributes as dividends and owner's personal income is $88,045 ($60,000 + $28,045), higher than if paid the full amount in dividends but the owner only paid so far $16,455 instead of $21,000 in taxes.
Stock Buyback
This, not well known, but a very efficient way of compensating oneself, takes advantage of lower long-term capital gain tax rates compared to income tax rates. The C Corp can use its retained earnings to repurchase its shares Say, Kelsi personally owns $79 in her company's shares. She bought them more than a year ago. C Corp decided to buy them back at a higher price since the company is doing much better than when she just founded it. So, she ends up receiving $79,000. Since she bought the shares more than a year ago, the proceeds from the sale will be recognized as a long-term capital gain and be subject to a maximum 20% tax unlike income tax that can be as high as 37%
Adding Capital
There are 3 ways owners can inject capital in the corporation.
Owner's capital
Additional Paid-in Capital
Loan
Owner's capital is the money paid to corporation in return for shares. The biggest advantage is that withdrawals are not taxable. If the owner bought 100 shares for $1000 and alter withdraws $500 from that he or she will lose control over 50 shares but will not pay tax on it. The disadvantage is that it affects the stock price of the company and if there are no longer authorized shares available, the company will need to change articles of incorporation and authorize more which may have a significant affect on the price of the stock.
Additional Paid-in Capital is the amount exceeding the par value of the stock. If the stock has a part value of $1, the corporation may sell it for a higher price and the additional amount will be the APIC. However, withdrawals from APIC are likely to be taxable.
Loans from owner to corporation help corporations and owners avoid affecting stock basis or paying tax on withdrawals. A loan, however, must have a clear understading on when and how the money will be repaid. Charging interest is not mandatory.