You have gone through the daunting task of starting a corporation. Your business name is chosen and registered, you've created your articles of incorporation and bylaws, and selected your directors. But, you may be asking yourself "now what?" Although the steps to creating a corporation can be overwhelming, that's only the beginning; now you must run your corporation properly.
Beyond the Day-to-Day
A corporation is a business structure that is regulated by state law. Unlike partnerships and sole proprietorships, a corporation is separate from the owner(s) and offers limited liability, that is it limits the owner's personal liability for business debts. A corporation is basically a separate entity; it can incur debts, pay taxes, and enter into contracts.
However, running a corporation takes more than fulfilling the day-to-day responsibilities of the business. You must hold shareholders' and directors' meetings, keep adequate records and minutes, and document any major corporate decisions. The formalities of running a corporation must be adhered to, and failing to abide by your corporate responsibilities can result in extremely negative legal situations. Below are some basic steps that must be followed by your corporation:
Hold Shareholders' and Directors' Meetings
By law, you must hold annual shareholders' and periodic directors' meetings, in which the corporation's business activities are reviewed and discussed. Shareholders own stock in the corporation and have the right to elect/remove directors; amend the articles of incorporation and bylaws; approve the sale of corporate assets; approve mergers; and dissolve the corporation. Directors have the authorization to issue stock; elect corporate officers (those who are responsible for the day-to-day operation and management of the corporation); set the salary amounts of employees and officers; make real estate decisions; and approve loans.
Board of Directors' meetings must be held at least annually, usually following the annual Shareholder meeting. All 50 states mandate that a Board of Directors' meeting is held at least once a year, and these meetings should be used to approve transactions entered into by the corporation. Every state also has requirements for shareholder meetings, but most states, such as California, require that shareholders also meet at least one a year to conduct shareholder business, such as electing directors to the board. Corporate minutes must be recorded and maintained at each of these meetings and be kept at the corporation's principal office.
States also vary for the specific requirements of directors. Corporations in California must have a minimum of three directors serving on its board unless the company has less than three shareholders. However, in this situation, the number of directors must not be less than the number of shareholders.
California also requires a corporation to draft and file the Articles of Incorporation. After the articles are filed, the bylaws must be drafted and the first meeting of the Board of Directors must be held. Corporate bylaws in California are not filed with the Secretary of State; an original or copy of the corporation's bylaws must be kept either at the principal business office or principal executive office.
Document Shareholders' and Directors' Corporate Decisions
Written minutes should always be taken and maintained for all corporate decisions made by shareholders and directors. Important decisions that must be documented include the actions at directors' and shareholders' meetings; the issuance of stock to shareholders; the purchase of property; the approval of a lease; the authorization of loans or other lines of credit; the adoption of stock options or retirement plans; and any significant federal or state tax decisions. Documenting these situations will protect an owner's limited liability status and will protect the owner if questioned by creditors or the IRS.
Maintain a Separation Between the Corporation and the Owners/Officers/Directors
Make sure the corporation's owners, officers and directors sign all documents in the name of the corporation, not their individual name. This includes any banking activities, such as checking accounts, loans or other banking procedures, as signing them in an individual's name would make that individual personally liable for the financial obligations. In addition, all contracts and leases should also be handled in the same manner.
Keep Detailed Financial Records
A corporation must use a double-entry bookkeeping system to record business transactions, and maintain financial records for the corporate tax return. A double-entry bookkeeping system is a method of recording financial transactions in which the financial condition and business operations are recorded in at least two accounts. These accounts keep a record of any changes in monetary values of the corporation, and each business transaction results in at least one account being debited and one account being credited, hence the double-entry term.
File a Separate Corporate Income Tax Return
Corporations must file and pay taxes on a corporate tax return that is separate from its owner; the owner is paid a salary just like any other employee. In addition, the owner must pay taxes on this income using a personal income tax return.
A corporation pays taxes using tax return Form 1120, which offers a special corporate tax rate, on any profits that are left after the corporation pays salaries, bonuses, and other deductible operating expenses. If shareholders elect to be an "S-corporation," the corporation then files Form 2553, which treats the corporation like a partnership for tax purposes, allowing business profits and losses to "pass through" the corporation to the owners' individual tax returns.
One financial disadvantage to corporations is double taxation; the corporation is taxed on profits and on any earnings paid out to the corporation's shareholders in the form of dividends. This is because dividends are not tax-deductible and tax must be paid by both the corporation and the shareholders. Please note that S corporations can alleviate this double taxation issue, as a single federal income tax is assessed at the shareholder level. S-corporations pass profit (or net losses) through to shareholders and the business profits are taxed at individual tax rates on each shareholder's Form 1040. This allows the corporation's profits to only be taxed once, at the shareholder level.