How to Incorporate a Business: Articles, Shares, EIN, S Election

How to incorporate a business: what are the steps, in order?

You create a corporation by filing with one state; the IRS steps come after the state approves it. The IRS asks you to form the corporation with the state before you apply for an EIN. The usual order:

1. Pick the state. Usually the state where you live and run the business.
2. Check the name and choose a registered agent with a street address in that state.
3. File the articles of incorporation (Delaware: certificate of incorporation; Texas: certificate of formation) and pay the state fee.
4. Adopt bylaws and take the first board actions: directors, officers, share issuance, bank account, tax year.
5. Issue founder shares, collect what each founder pays, and record it in the stock ledger.
6. Get the EIN from the IRS. It is free.
7. Open a bank account in the corporation's name.
8. Decide on S status. If you want it, file Form 2553 inside its window.
9. Register in any other state where the corporation does business.
10. Calendar the first deadlines: the state report and tax, estimated tax, payroll if owners work in the business, and the first Form 1120 or 1120-S.

What makes it harder: two or more founders (who owns what, what each pays, whether shares vest); property or an existing business moved in for shares (a control test decides whether that is taxed); a formation state different from where you work (two states' fees, reports and taxes); S status (a short deadline, every shareholder's consent, and no corporations, partnerships or nonresident aliens as owners); and owners who work in the business (officers paid for services are employees, so payroll starts with the first salary).

What to gather before you file:

• The corporation's name, with a backup.
• The registered agent's name and in-state street address.
• How many shares to authorize, and their par value or no par value.
• Names and addresses of the directors and officers.
• Each founder's share count, price, and what they pay with: cash or property.
• For property: its cost, tax basis, current value and any debt on it.
• The responsible party's Social Security number or ITIN for the EIN.
• The date the corporation first has owners, assets or business activity, and the tax year you want.

Which state should you incorporate in?

Usually the state where the business operates. A corporation formed in one state that does business in another generally has to register there too, so it pays fees, files reports and may owe tax in both. Delaware, for example, requires every corporation formed there to file an annual report, and most to pay franchise tax, even when they operate elsewhere (Delaware Division of Corporations).

The choice itself is covered in which state to form in, and the home-state filing in registering in another state.

What goes in the articles of incorporation, and what does it cost to incorporate?

The articles are a short public filing. States ask for much the same core items, though forms differ:

Sources: Delaware Code, title 8, section 102 and the Texas Form 201 instructions. For who can serve as agent, see registered agent.

The state filing fee is the main fixed cost. Three examples:

Add a registered agent if you hire one, and the yearly state report and tax in the table further down. The EIN costs nothing: the IRS never charges for one. In Delaware, the number of authorized shares can drive the yearly franchise tax; see Delaware franchise tax.

Bylaws and the first board actions: what has to be approved?

Bylaws are the corporation's internal rules; they are not filed with the state. After the filing, the incorporator, or the initial directors if the articles name them, adopt the bylaws and elect directors, and the directors appoint officers. In Delaware this happens at an organization meeting or by written consent (Delaware Code, sections 107–109). Other states have similar rules.

The first actions usually cover:

• Bylaws, including the number of directors.
• Directors. Delaware requires one or more, each a natural person, who need not own shares (section 141).
• Officers, such as president, secretary and treasurer. In Delaware one person can hold several offices unless the certificate or bylaws say otherwise, and one officer keeps the minutes (section 142).
• Share issuance: who gets how many shares, at what price, paid with what.
• The bank account and who may sign.
• The tax year. A corporation generally adopts its tax year by filing its first federal return on it (Publication 542). An S corporation, or a personal service corporation (mainly health, law, accounting, consulting or similar services performed by its owner-employees), must use a calendar year unless it shows a business purpose for another (section 1378; Publication 542) or makes a separate election to use another year (Form 2553 instructions).
• Applying for the EIN and, if wanted, the S election.

Keep the signed consents or minutes with the stock ledger. They are the record a bank, a tax preparer or a later buyer may ask to see.

How do you issue founder shares, and does putting in property trigger tax?

Authorized shares are the ceiling in the articles; issued shares are the ones the board actually sells to owners. Issuing only part, such as 1,000 of 10,000, leaves room for later owners without amending the articles.

The board decides the price and what it accepts: cash, property or another benefit to the corporation (Delaware Code, section 152). Shares with a par value cannot be issued for less than par (section 153; Texas says the same in its Form 201 instructions). Record each issue in the stock ledger: holder, number of shares, date and what was paid. Shares that were never formally issued, or never paid for, leave ownership unclear just when the S election, a bank or a buyer needs it settled.

Shares received for work, or shares that vest, follow different rules; see founder shares that vest.

Property for shares: the section 351 control test

Moving property into a corporation in exchange only for its shares is generally not taxed when the people transferring property, as a group, control the corporation immediately afterwards: at least 80% of the voting power and of each other class of shares (section 351(a); section 368(c)). It applies whether the corporation is new or already running (Publication 542).

What changes the result:

• Cash or other property back from the corporation is taxed up to the gain (section 351(b)).
• Debt the corporation takes over is taxed as gain to the extent it exceeds the total tax basis of the property transferred, and counts as cash back if moving it had no business purpose or was mainly to avoid tax (section 357(b) and (c)).
• Work is not property. Shares issued for services do not count toward the exchange (section 351(d)).

With no cash back and no debt taken over, the owner's shares take the owner's tax basis in the property, and the corporation generally does too; property worth less than its basis has special limits (section 362(e)). The corporation and the transferors attach the statement Treasury Regulations section 1.351-3 requires to their returns for the year of the exchange (Publication 542). For the bookkeeping entries, see setting up books for a new corporation.

When do you get the EIN, and who is the responsible party?

Apply after the state approves the corporation; applying first can delay the EIN. The online application is free and issues the number at once if the corporation's main place of business is in the US and the responsible party has a Social Security number or ITIN. Otherwise apply by fax or mail, or by phone if the corporation has no office or place of business in the US; see an EIN without an SSN.

The responsible party is the individual who ultimately owns or controls the corporation and directs its funds and assets. It must be a person, not a company. The IRS issues one EIN per responsible party per day, and a change of responsible party must be reported on Form 8822-B within 60 days (Form SS-4 instructions).

On the application you name the return the corporation will file. Writing "1120-S" there does not make the S election: until Form 2553 is received and approved, the IRS treats the corporation as a Form 1120 filer (Form SS-4 instructions).

C corporation or S election: when is Form 2553 due?

A new corporation is a C corporation unless it files Form 2553. A C corporation pays federal tax of 21% on its profit, and shareholders are taxed again on dividends (IRS). An S corporation's income passes to the shareholders' personal returns instead (IRS). To qualify, it must be a domestic corporation with no more than 100 shareholders, only eligible shareholders (individuals, estates, certain trusts and exempt organizations; no corporations, partnerships or nonresident aliens) and one class of stock (Form 2553 instructions). Which status fits is covered in C corporation or S corporation, and who may own one in S corporation eligibility.

The deadline is no more than 2 months and 15 days after the start of the tax year the election should cover (Form 2553 instructions). For a new corporation, the first tax year starts on the earliest of the dates it first had shareholders, first had assets, or began doing business. An election filed before that date is not valid.

• Worked date from the IRS instructions: a first tax year that begins January 7 gives a window from January 7 to March 21.
• Missed it: the election generally starts the next tax year unless late-election relief applies; see late S election relief.

An officer signs, and every shareholder consents, including a spouse who shares a community property interest in the shares (Form 2553 instructions). Filing and confirming acceptance are covered in S corporation from day one. Some states, New York among them, need their own S election (New York Form CT-6 instructions); see state S corporation election.

What does the state want after you incorporate?

Most states want a yearly or every-other-year report, and many charge a franchise or minimum tax whether or not the corporation makes money. The names and dates differ by state; three examples:

Sources: California Secretary of State, California filing periods, California Franchise Tax Board and its S corporation page, Delaware, Texas Comptroller, its filing requirements and its first-report rules.

Missing these has a cost. Delaware charges $200 for a late annual report, plus interest. In California, a missed Statement of Information can bring a $250 penalty and suspension. In Texas, if a missed report or tax leads to forfeiture, each officer and director is personally liable for corporate debts created in Texas from the due date until the corporation is revived (Texas Tax Code section 171.255). More detail: California minimum tax, Delaware franchise tax and Texas franchise tax. A corporation registered in a second state owes that state's reports too.

What does a new corporation file with the IRS in its first year?

Three federal duties start in year one:

• A return, even with no income. Every domestic corporation files Form 1120 whether or not it has taxable income (Form 1120 instructions), generally by the 15th day of the fourth month after year-end: April 15 of the following year for a calendar year. An S corporation files Form 1120-S instead, by March 15 for a calendar year. If it is formed late in the year, see first tax year of a new company.
• Estimated tax. A C corporation that expects to owe $500 or more for the year pays installments by the 15th day of the fourth, sixth, ninth and twelfth months, generally through EFTPS, the Treasury's electronic payment system (Publication 542). See first-year estimated tax for a new corporation; for an S corporation, see S corporation estimated tax payments.
• Payroll if owners work in the business. A corporate officer who performs services and is paid, or is entitled to pay, is an employee, and the pay is wages subject to withholding and payroll taxes. Owning shares does not change that, and courts have treated distributions paid instead of wages to S corporation owners who work in the business as wages (IRS). A person responsible for paying over withheld taxes who willfully fails to can be personally liable for the full unpaid amount, the trust fund recovery penalty (Publication 542). See setting up payroll and S corporation owner salary.

The state fee and legal costs of forming the corporation are organizational costs with their own deduction rules; see setting up books for a new corporation.

Does a new corporation file a BOI report?

No. Under FinCEN's final rule, companies formed in the US are exempt from beneficial ownership information reporting; only certain foreign companies registered to do business in a US state still report (FinCEN). See BOI report: who still files.

Example

These examples are illustrative; figures are in US dollars.

A Texas contractor elects S status from day one

An Austin contractor files a certificate of formation with Texas and pays the $300 fee. On March 10 she gets the EIN, and the board consent issues her 1,000 of the 10,000 authorized shares for US$1,000, which she deposits in the new corporate account that day.

The corporation first has a shareholder and assets on March 10 and did no business before, so its first tax year starts then. The two-month period ends May 9, and 15 days later is May 24. She files Form 2553 on April 20, so S status can start on day one once the IRS accepts it. She puts herself on payroll before taking any distribution, and files Texas's report each May 15, starting the year after she incorporates.

Two co-founders move equipment and cash in for shares

Two co-founders who have not been in business together incorporate in their home state. Founder A transfers equipment worth US$20,000, with a tax basis of US$8,000 and no debt on it, for 2,000 shares. Founder B pays US$20,000 cash for 2,000 shares.

Right after the exchange, the two transferors own 100% of the shares, above the 80% control line. A is not taxed on the US$12,000 gain built into the equipment. Her shares and the corporation's basis in the equipment are both US$8,000. Had A taken 1,500 shares and US$5,000 in cash instead, she would be taxed on US$5,000 of the gain; her shares would still have a US$8,000 basis, and the equipment a US$13,000 basis. The corporation and both founders attach the exchange statement to their returns.

A New York owner incorporates in Delaware

A New York owner forms a Delaware corporation with 5,000 authorized shares and runs the business from New York. Each year by March 1, Delaware wants an annual report ($50 fee) and franchise tax ($175 minimum under the authorized shares method), and the corporation keeps a Delaware registered agent.

Before doing business in New York, she files an Application for Authority there ($225 fee, with a Delaware certificate of existence dated within the past year); filing after starting would also need the New York State Tax Commission's consent. She then makes the New York corporate tax filings for the business she runs there. The same business formed in New York would skip the Delaware layer.

Different for you?

• You have not chosen between an LLC and a corporation: compare LLC or C corporation, or see how to form an LLC.
• You are deciding on S status, or the Form 2553 date is close: read C corporation or S corporation and S corporation from day one, and get business formation help before the window closes.
• You formed in one state and work in another: see registering in another state and get business formation help to set up both states' filings.
• You are raising venture money in a Delaware corporation: see Delaware C corporation for a startup and founder shares that vest.
• A founder is not a US citizen or US tax resident: a corporation with a nonresident alien shareholder cannot be an S corporation, whatever the visa; see S corporation eligibility and Delaware C corporation for a non-resident founder.
• You already run the business, or founders are moving property in: see changing your business structure, and check the control test with business formation help before the transfer.
• You hold a professional license: your state may require a professional corporation with its own articles; see professional LLC or professional corporation.
• The first payroll or first return is coming: see after you form your company, setting up books for a new corporation and setting up payroll; get bookkeeping from the first deposit and corporate tax help for the first Form 1120 or 1120-S.