Incorporation is designed to encourage investment in a company by relieving investors of the risk of losing their personal assets to business creditors. Nevertheless, incorporation involves both positive and negative aspects; it is not a good idea for every company. Although corporate law varies slightly from state to state, you don't have to do business in a state to incorporate there.
To incorporate, you must file Articles of Incorporation with the appropriate state-governing agency such as the secretary of state or corporation division. Articles of Incorporation are typically only a page or two long; they list the name of the corporation, the name of the person filing the Articles of Incorporation, the name and address of the corporation's registered agent, the corporation's registered address, the number of shares the corporation is authorized to issue, the nominal value of each share and the corporation's business purpose. Some states may require additional information.
A sole proprietorship or general partnership can incorporate itself directly by filing Articles of Incorporation and issuing shares to its owners. A business entity registered with the state government -- such as a limited liability company or a limited partnership -- might have two options, depending on its state of formation. One option, available in every state, is to formally dissolve the entity in the manner prescribed by state law; for example, an LLC might file Articles of Dissolution, and then file Articles of Incorporation. Some states, however, offer a process by which a registered business entity may incorporate itself by filing a conversion document along with its Articles of Incorporation. Texas, for example, allows an LLC to file a Certificate of Conversion of a Limited Liability Company Converting to a Corporation, and a Certificate of Conversion of a Limited Partnership Converting to a Corporation.
Corporate Formalities and Limited Liability
In exchange for having limited liability, corporations must observe certain formalities. A corporation must hold an annual shareholders' meeting, hold periodic board of directors' meetings, hold formal votes of directors or shareholders to decide certain important matters, record minutes of meetings, maintain a corporate bank account, keep comprehensive and accurate financial records, and fund the corporation with enough assets to meet reasonably foreseeable future liabilities. If the corporation fails to observe these formalities, a court might strip the corporation of its limited liability and allow corporate creditors to reach the personal assets of shareholders. Although most corporations create corporate bylaws that function as a corporate constitution, bylaws do not have to be filed with any state entity.
Incorporation entails significant tax consequences because corporations are taxed differently than other business entities. When a corporation is first formed, its income is taxed under Subchapter C of the Internal Revenue Code. Taxable income is taxed at corporate tax rates, and then taxed again when it is distributed to shareholders or employees in the form of dividends or salaries. A corporation that qualifies under the Internal Revenue Code may elect to be taxed under Subchapter S by filing Form 8832 with the IRS. An "S" corporation must meet certain standards, such as having no more than 100 shareholders. S corporations are taxed in a manner similar to general partnerships -- the corporation itself is not taxed on most forms of income, but shareholders are taxed on their proportionate share of corporate taxable income. Many state governments tax corporations in a manner similar to the IRS. Other corporate taxes may apply, such as the accumulated earnings tax.