Business Law FAQs

Helping individuals and organizations

What are the benefits of incorporation?

Incorporation provides many benefits. By incorporating you can limit your personal liability as a business owner. Creditors of your corporation must satisfy their claims by seizing the assets of the corporation rather than your personal assets. In contrast, as a sole proprietor or partner in a general partnership you are financially responsible for all liabilities of the business, and your personal assets are subject to seizure or lien by creditors.


Other benefits of incorporation can include greater tax deductions for health insurance and medical expenses, lower payments for social security tax and medical tax, and greater opportunity to raise capital for the business through the issuance of stock.

In which state should I incorporate?

Generally, you should incorporate in the state where your office is physically located.

If you incorporate in another state such as Delaware, you may need to submit an application to qualify as a foreign corporation in the state where your office is physically located.

What services does the registered agent provide?

State laws require that a person located in the state of incorporation be available during regular business hours to receive legal notices and other official documents. That person is called the registered agent.


In the United States, a registered agent is a business or individual designated to receive service of process (SOP) when a business entity is a party in a legal action such as a lawsuit or summons. The Registered agent for a business entity can be an individual or more often a third party such as the organization's lawyer or a service company. Failure to properly maintain a registered agent can affect a company negatively.

Are there annual filings if I incorporate?

Yes. In general, corporations file an annual tax return (IRS Form 1120 or 1120S) and a simple one page annual state report that updates information such as the address of the corporation and the names of its current officers and directors. (The names of the shareholders are generally not listed in the annual state report.)


Note that annual tax returns are filed by sole proprietorships (Schedule C to IRS Form 1040), limited liability companies (IRS Form 1065) and general partnerships (IRS Form 1065).

How many directors and officers are required to form a corporation?

In California, one person is enough to form a corporation. The same person may hold the offices of President, Secretary and Treasurer and may be the only person on the Board of Directors. The officers manage the daily business of the corporation based on the instructions of the Board of Directors. If you have more than one shareholder then you need to have different parties holding different positions unless there are more then 3 shareholders. With 3 or more shareholders only 3 people need to hold a position.

Who owns the corporation?

The corporation is owned by the shareholders. A corporation may have one or more shareholders. In general, since the shareholders elect the persons who serve on the Board of Directors, the corporation is controlled by the shareholders. The shareholders that own more than 50% of the corporation's common stock get to make the ultimate decisions about running the corporation.

What are the requirements for foreign ownership of an U.S. company?

Generally, there are no restrictions on foreign ownership of a company formed in the United States. The procedure for a foreign citizen to form a company in the United States is the same as for an U.S. resident. It is not necessary to be an U.S. citizen or have a green card to own a corporation or limited liability company formed in the United States. To receive pass-through profit distributions, a foreign citizen may form a limited liability company. In contrast, all profit distributions (called dividends) made by a C corporation are subject to double taxation. (Under U.S. tax law, a foreign citizen may own shares in a C corporation, but may not own any shares in an S corporation.) For this reason, many foreign citizens form a limited liability instead of a C corporation.


A foreign citizen may be a corporate officer and/or director, but may not work in the United States or receive a salary or compensation for services provided in the


United States unless the foreign citizen has a work permit (either a green card or a special visa) issued by the United States. Some work permits allow a foreign citizen to work only for a sponsoring employer. Such work permits generally do not enable a foreign citizen to also work for a new, unrelated company formed by a foreign citizen. The foreign citizen would need to obtain a separate work permit to work for the new company. We do not provide immigration advice.

What is a nonprofit corporation?

The process to form a "for profit" versus "nonprofit" corporation is similar, but the text of the articles of incorporation is different. There are no owners in a nonprofit corporation. Instead, a board of directors controls a nonprofit corporation. The profits of a nonprofit corporation may not be paid to the "founders" of the nonprofit, except that the founders may receive compensation for the fair market value of actual services provided to the nonprofit. In general, a nonprofit corporation will seek charitable contributions from the public; the nonprofit must apply for 501(c)(3) status, which is a separate application that should be filed within 15 months after incorporation of the nonprofit.

What is a C corporation?

The term C corporation refers to the way in which the corporation is taxed. There is a corporate level income tax on the profits of a C corporation. In addition, if a dividend is paid to shareholders from retained earnings, the dividend is included on the personal tax return of each shareholder. Thus, the profits of a C corporation are subject to potential double taxation. Your corporation will be taxed as a C corporation this year unless you timely file IRS Form 2553 to elect tax treatment as an S corporation.

What is an S corporation?

The term S corporation refers to the way in which the corporation is taxed. An S corporation is a pass through entity. There is no corporate level income tax. Instead, a pro rata portion of the annual profit or loss of the S corporation is included on the personal tax return of each shareholder. If IRS Form 2553 is filed within 75 days after incorporation, the corporation will be treated as an S corporation for tax purposes. Many start-up businesses benefit by making the election to be taxed as an S corporation.

How does an S corporation differ from a limited liability company?

A limited liability company (LLC) is like an S corporation. Generally, business owners form an LLC rather than an S corporation if one or more of the following situations apply:


      1. ANY owner of the company is another business entity or non-resident alien           (a person is a nonresident alien if he or she is neither a resident nor a           citizen of the United States).


      2. The company will be owned by more than 75 persons.


      3. The company plans to issue more than one CLASS of stock (for example,           special allocations of profits and losses will be made that are not           proportionate to the equity percentage of each owner.)


      4. The owners desire to use business debt (money borrowed by the (company)           to increase their tax basis.


      5. The state where your business is located imposes an entity level income tax           on the profits of an S corporation and does not impose such a tax on the           profits of an LLC.


If these situations do not apply to you, than an S corporation should do the job. Generally, the LLC is treated like a partnership for tax purposes and there is no entity level tax. Under the recently approved IRS check-the-box regulations, an LLC will be taxed like a partnership unless the members elect to have the LLC taxed like a C corporation (association). Prior to the check-the-box system, to be taxed like a partnership, an LLC could have no more then two of the following four characteristics of a corporation:


      1. Limited Liability;


      2. Centralized Management;


      3. Continuity of Life;


      4. Free Transferability of Ownership Interests


Most LLC's have only the first two characteristics. Formation of an S corporation or an LLC can offer many benefits including limited liability and tax savings. An LLC also provides liability protection like a corporation.

How does an S corporation differ from a C corporation?

Some start-up companies benefit by starting out as an S corporation, while others remain as C corporations because the owners desire to deduct 100% of medical expenses, the corporation fails to qualify for S corporation status, or the shareholders desire to have the opportunity to exclude from gross income 50% of the gain from the sale of "qualified small business stock" (explained below). Generally, a corporation fails to qualify for S corporation status if one or more of the following situations apply:


      1. ANY owner of the company is another business entity or a nonresident alien (a           person is a nonresident alien if he or she is neither a resident nor a citizen of the           United States).


      2. The company will be owned by more than 75 persons.


      3. The company plans to issue more than one CLASS of stock (for example, special           allocations of profits and losses will be made that are not proportionate to the           equity percentage of each owner).


If the above situations do not apply to you, than the corporation may apply for the S corporation status by timely filing IRS Form 2553. The law requires submission of form 2553 for the S election within 75 days after the corporation first has assets, shareholders or starts doing business. If you miss the deadline, you may file Form 2553 within 75 days after January 1, but there might be tax consequences. If a corporation fails to qualify for S corporation status, than the corporation must be a C corporation. With a C corporation, 100% of the medical expenses incurred by you (as a shareholder and employee), your spouse and your children are tax deductible. In a sole proprietorship, only 45% of such medical expenses are tax deductible for the 1998 tax year.


In 1993, Section 1202 of the Internal Revenue Code was enacted to provide a 50% exclusion of any capital gain from the sale of "qualified small business stock." For shares to qualify for the exclusion, several tests must be met. For instance:


      1. Shares must be purchased directly from a C corporation and the shares must be           held for at least five years (shares do not qualify if purchased in any later trading           market).


      2. A "qualified small business" must have not more than $50 million in assets at all           times before and immediately after the issuance of stock.


      3. At least 80% of the corporation's assets must be used in the "active conduct of           one or more qualified trades or businesses" throughout the holding period.


There are also limitations on the persons who may use the exclusion. You should consult your own tax advisor as to the availability of the capital gains tax exclusion.

How does an S corporation differ from a sole proprietorship?

With an S corporation, the distribution of S corporation profits is exempt from the 15.3% social security/Medicare tax that is imposed on wages. The shareholder of an S corporation saves about $1530 for every $10,000 profit distribution ($10,000 x 15.3% = $1530) because the entire profit distribution is exempt from the social security/Medicare tax. The tax savings strategy is commonly called "wage reduction." Remember to pay a reasonable wage if you implement the wage reduction strategy. By contrast, in a sole proprietorship, all self-employment income is subject to the 15.3% social security/Medicare tax (called self-employment tax in the context of a sole proprietorship). If you are the sole owner of a business that has not incorporated, your business is considered a sole proprietorship.


The 15.3% security/medical tax is comprised of a 12.4% social security tax and a 2.9% Medicare tax. Wages higher than $76,200are exempt from the 12.4% social security portion of the tax. Note, however, that the 2.9% Medicare portion of the tax is applied to all wages (and self-employment income), without an upper limit. In addition to the tax savings benefit explained above, there are liability protection reasons for choosing to run your business as an S corporation. With an S corporation, your liability is limited to the money you invest in your business. With a sole proprietorship, you have unlimited personal responsibility and all of your personal assets are subject to the rights of creditors to seize or place a lien against your personal assets and treat the S corporation like a C corporation.