![]() So why were those companies denied limited liability status, and how can you avoid that situation for yourself?įirst of all, incorporate in Delaware rather than another state! Delaware courts uphold the corporate liability shield much more frequently than other states. This means that 40% of corporations that needed liability limitation the most were no better off than had they not formed a corporate entity at all. In this Cornell law review article analyzing almost 1600 legal cases, it was found that a whopping 40% of the time courts decided to “ pierce the corporate veil” (which is a fancy way of saying the courts decided to disregard the corporate entity and hold shareholders directly liable for debts, fines, or damages). Failing to follow the rules of incorporation precisely can jeopardize not just your entire corporation, but also the liability limitation afforded to shareholders. Corporations have centuries of additional case law beyond what LLCs have in this regard so their liability rules are much more predictable.Įvery state has slightly different rules when it comes to incorporating a c-corporation in that state, and these state-specific incorporation differences REALLY matter. ![]() In fact, the tax status of “c-corporation” can actually be used by an LLC business entity, so the primary purpose of forming a company as a corporation at all is really just to take advantage of the state-level liability laws (for shareholders, corporate officers, and the corporation itself). However, since each corporation must incorporate in a particular state with its own particular state corporate laws, the liability protections that a corporation offers are NOT determined federally but rather differ on a state-by-state basis. The first “c” of “c-corporation” refers to the tax rules of subchapter C of the IRS income tax code, and these tax rules are determined federally by the IRS (although states do impose a few corporate tax rules as well). Step 1: Avoid the Incorporation Mistake that Renders up to 40% of Corporations Worthless Public utility company (electricity, gas, water, etc).If you don’t fall into any of the following categories, then proceed to step 1 below.īusiness Categories with Special Incorporation Requirements If your business falls into any of the following categories, I highly advise you to seek out a lawyer to assist in incorporation. Some types of heavily-regulated businesses must follow different procedures for incorporation. That assumption is false, and I will explain why in the relevant steps of this guide. Unfortunately, it’s all too common for inexperienced founders (cough, me when forming my first company, cough) to assume that any of the online incorporation services or guides is about as good as any other as long as they file my formation documents. The purpose of incorporating a business as a c-corporation is two-fold: to take advantage of tax benefits and to limit the liability of shareholders when things go wrong in the business. This is a much longer article than your typical copypasta “how to incorporate” blog article, but I highly recommend reading the entire thing to save yourself from unnecessary four to five-figure costs and seven-figure liability exposure. ![]() In this article, I’ve organized the requirements and best practices for all of these stages into a single step-by-step guide with detailed explanations of how to make each decision and how to avoid certain tax & legal pitfalls that I’ve learned about over the course of starting seven companies and now investing in others. The formation of a new corporation has three stages: (A) making pre-incorporation decisions about issues such as the number of shares to issue, which can affect taxes by an order of magnitude as well as affect your ability to engage in certain financial contracts, (B) formally incorporating your company, and (C) taking certain legally prescribed post-incorporation actions such as holding an organization meeting, formally electing certain directors or officers, and adopting bylaws.
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