OVERVIEW OF CORPORATIONS
Corporations formed under California law are governed by California’s General Corporation Code. Entrepreneurs can incorporate a business as either a traditional “C” corporation or an “S” corporation. There are elements common to both corporate forms, and areas where the two differ. The common elements are (1) basic management structure and (2) limited liability; the elements that differ are (3) filing requirements and (4) income taxation.
(1) BASIC MANAGEMENT STRUCTURE
The key players involved with incorporating a business in both C and S corporations are the incorporator(s), shareholders, directors, and officers. The same person or persons can serve in multiple roles, which is common when forming a corporation in California.
The incorporators (also called “promoters”) are generally only involved at the beginning of forming a corporation. They perform the preparatory work involved in starting a corporation, which may include making sure the articles of incorporation are filed, or organizing capital to initially start a business. California Corporations Code §200 describes incorporators as “one or more natural persons, partnerships, associations or corporations, domestic or foreign,” which means that people or business entities can form a corporation.
Shareholders own the stock of the corporation in exchange for investing in the company. One person can own all of the corporation’s stock. Shareholders have the power to elect and remove directors, amend bylaws or articles of incorporation, approve or vote down sales of corporate assets or mergers, and dissolve the corporation. Shareholders are required under California Corporations Code §600(b)-(c) to hold annual meetings.
The directors manage the corporation and are responsible for major policy decisions such as the issuance of stock and electing the corporate officers. As mentioned before, shareholders determine who the directors of a corporation will be. Under California Corporations Code §212(a) the minimum number of directors a corporation may have is three unless the corporation has only one or two shareholders, in which case it may have as few as one or two directors respectively.
The officers are responsible for the day-to-day operation of the corporation. California Corporations Code §312(a) requires that every corporation have at a minimum a chairman of the board or a president (or both), a secretary, and a chief financial officer, also traditionally called a treasurer. A president or chairman of the board is considered the chief executive officer of the corporation, while the secretary is responsible for keeping the corporate records. The treasurer is responsible for the corporate finances, although it is acceptable to delegate day-to-day duties to a bookkeeper. The corporation can also authorize in its bylaws other officers such as a vice president. In California, the same person can hold any number of the required offices.
(2) LIMITED LIABILITY
Generally, both C and S corporations are entities that shield shareholders from liability for the corporation’s obligations. This means that shareholders cannot, for example, be held responsible for paying a debt incurred by the corporation; only corporate assets, not shareholders’ personal assets, can be used to pay such debts.
However, both types of corporations must strictly adhere to corporate formalities to maintain limited liability status. Among other things, failure to hold meetings, maintaining inaccurate records (or no records at all), or inadequate capitalization (i.e., not enough money in the bank to operate the business) can result in creditors or plaintiffs in lawsuits against the corporation “piercing the corporate veil” and seeking payment from shareholders’ personal assets.
In addition to counseling before and after starting a corporation in California, the firm also provides in its incorporation packages the initial documentation for running your corporation related to the first Board of Directors meeting (Notice/Waiver of Meeting, Proposed Agenda and Resolutions, and Minutes).
(3) FILING REQUIREMENTS: DIFFERENCES BETWEEN C AND S CORPORATIONS
To begin operating in the corporate form, both C and S corporations in California are required to file articles of incorporation because California law says that “corporate existence begins upon the filing of the articles…” However, the key difference in filing requirements for S corporations is the need to make an “S-corporation election” by filing “Form 2553, Election by a Small Business Corporation” with the IRS. By filing the S-corporation election form, the corporation is essentially deciding to be taxed as a partnership (see section 4 below).
There are four requirements for electing S corporation status, so this corporate form is not available to all businesses wishing to form a California corporation. The four requirements are:
- No more than 100 shareholders are allowed in the corporation.
- All shareholders must be individuals.
- No shareholder can be a nonresident alien.
- The corporation can only have one class of stock.
The firm’s business formation attorney Michael J. Thomas will counsel you on whether an S corporation election is right for your business before incorporating, and can even file the election for you if you choose, but this filing is not included in the firm’s incorporation package, so extra charges will apply.
Filings Common to Both C and S-Corporations
Besides the articles of incorporation, two other Secretary of State filings related to forming a California corporation are a “name reservation” and a “statement of information”. Businesses considering incorporating as C or S corporations in California should carefully consider the naming of their corporation. Before deciding on your corporation’s name (and definitely before purchasing advertising, etc.), a search of California Secretary of State records should be performed. Upon determining that your proposed corporate name is available, a name reservation form should be filed before the articles of incorporation to ensure that the name of your corporation is available when you want to incorporate (name reservations are good for 60 days).
However, despite the availability of a corporate name in California’s business records, your proposed name may be subject to someone else’s trademark rights under federal or common law. If you are interested in making sure you will be able to use your corporate name without worrying about potential trademark litigation, the firm offers a trademark registration package that includes a comprehensive nationwide trademark search with analysis by a licensed practicing attorney and more.
Within 90 days following the date your company is incorporated, a “Statement of Information” (SI) form must also be filed. The firm takes care of the name reservation and SI so you can focus on the success of your new business startup.
The issuance of shares by either an C or S-corporation raises securities issues. Securities issued in California must be either exempted or qualified. Qualification is an expensive and time-consuming process, so thankfully small business owners forming a California corporation can rely on an exemption provided by Cal. Corp. Code §25102(f). This exemption can be relied upon by filing what is know as a “Limited Offering Exemption Notice” (LOEN) with the California Department of Business Oversight (DBO). However, a California corporation must meet all of the requirements of §25102(f), which are:
- The sale of securities is limited to no more than 35 unaccredited investors, (including those located outside California but not including officers and directors of the corporation);
- each investor is required to have a pre-existing business or personal relationship with the issuer of the securities, or, in the alternative, can be demonstrated to be a sophisticated investor,
- advertising of the securities is prohibited, and
- at the time of the share purchase, the investor must not intend to resell the securities.
The firm will analyze the facts surrounding your incorporation to determine if you meet the qualifications for a §25102(f) exemption, and if so, file the LOEN as part of your incorporation package.
(4) INCOME TAXATION: DIFFERENCES BETWEEN C AND S CORPORATIONS
The most common reason for those incorporating a business in California to choose an S corporation is to have “pass-through” tax liability in which the S corporation is treated like a partnership. This means that the income, gains, losses, deductions, and credits of the S corporation pass through to its members for reporting on their personal income tax returns.
In contrast, the income of a C corporation is taxable by federal and state governments at the corporate tax rate. This leads to “double taxation”, because (1) the corporation pays tax on its income, and (2) the shareholders pay tax on dividends received from the corporation. However, corporate tax rates are generally lower than individual tax rates, and there are steps you can take that will diminish the effects of double taxation.
