Everyone who earns money from business activities should determine whether they would benefit from forming a legal entity, and if yes, what type of legal entity is best for their individual use-case.
When and why to form a corporate entity
There are a couple of key issues that might play into a decision to form a corporate entity:
- Liability protection - When your activities have received significant traction or you are launching a new initiative, there is always a chance that things might go wrong. Incorporating can sometimes protect you from personal liability.
- Protecting intellectual property - When multiple people are involved in the creation of the venture, you'll want to make sure that the intellectual property is assigned to a corporate entity. Otherwise, things might get tricky when someone leaves.
- Hiring - When you bring onboard employees or contractors, you'll want to make sure that it is the company, and not you personally, who enters into an agreement with them.
- Fundraising - If you intend to rely in part on capital from outside sources (investors), you'll need a legal entity to open a bank account and accept the investment.
Choosing the right corporate form
There are many entity types you can choose from, and each has its own purpose and advantages. Not every entity type is available in every state, but the choice between each type largely comes down to just a few key questions.
|Description||A one-person business which can use a unique business name without a formal entity.||When 2 or more people go into business without any formal entity created.||Limited liability for the owners. Less burdensome than a corporation.||Similar to a corporation, but profits flow through the owners. This is generally an option for smaller corporations.||Legal entity that is distinct from the owner(s) of the business. The corporation is responsible for its own debts and liabilities.|
|Pros||No government filing required.||No government filing required.||Combines limited liability of a corporation with the pass through taxation of a small proprietorship. There are fewer formalities than with a S-Corp or C-Corp.||Similar to C-Corp except profits and losses are divided among shareholders. Considered a pass through entity.||A C-Corp can have any number of shareholders. Only liability for the shareholder is the amount of money invested in the corporation.|
|Cons||No legal separation between owner and the business.||Tax liabilities passed to individuals.||Filing and other fees may be higher than for a corporation.||To protect shareholder assets, formalities must be followed (meetings, reports, etc). This can be time and cost intensive.||To protect shareholder assets, formalities must be followed (meetings, reports, etc). This can be time and cost intensive.|
|Taxes||Profits/Income passed through to individual. Taxes are filed by the individual.||Profits/Income passed through to partners. Taxes are filed by the individual partners.||Profits/Income passed through to individual(s). Taxes are filed by the individual partners.||Profits are passed through to the shareholders. Shareholders file individual taxes.||Double-taxation. This means the corporate entity is taxed, and then profits distributed to individuals are taxed again.|
Registering Your Business
Once you’ve determined that you should create a corporate entity and chosen a corporate form, you will want to take the necessary steps to register. Registering your business to make it a distinct legal entity. How and where you need to register depends on the business structure you choose and the business location. For most small businesses, registering your business is as simple as registering your business name with state and local governments. In some cases, you don’t need to register at all. But while you may not need to register If you conduct business as yourself using your legal name, you could miss out on personal liability protection, legal benefits, and tax benefits.
Most businesses don't need to register with the federal government to become a legal entity, other than simply filing to get a federal tax ID. Small businesses sometimes register with the federal government for trademark protection or tax exempt status.
If your business is an LLC, corporation, partnership, or nonprofit corporation, you'll probably need to register with any state where you conduct business activities. You’ll also need a registered agent in your state before you file. A registered agent receives official papers and legal documents on behalf of your company, and many business owners prefer to use a registered agent service rather than do this role themselves. Some states allow you to register online, and some states make you file paper documents in person or through the mail. Most states require you to register with the Secretary of State’s office, a Business Bureau, or a Business Agency.
If your business is an LLC, corporation, partnership, or nonprofit corporation, you might need to file for licenses and permits from the county or city. Some counties and cities also require you to register your DBA, a trade name or a fictitious name, if you use one. Local governments determine registration, licensing, and permitting requirements, so visit local government websites to find out what you need to do.
Get Federal and State Tax IDs
An employer identification number is like a social security number for your business. You’ll need it for important steps to start and grow your business, like opening a bank account and paying taxes. Some, but not all, states require you to get a tax ID as well.
Apply for licenses and permits
The licenses and permits you need for your business will vary by industry, state, location, and other factors. Keep your business running smoothly by staying legally compliant. Read our guide on licenses and permits you may need at both state and federal levels.
Open a business bank account
Open a business account when you're ready to start accepting or spending money as your business. You can open a business bank account once you've gotten your federal EIN. A business bank account helps you stay legally compliant and protected, and benefits your customers and employees. Common business accounts include a checking account, savings account, credit card account, and a merchant services account. Merchant services accounts allow you to accept credit and debit card transactions from your customers.
Find an account with low fees and good benefits. Rates, fees, and options vary from bank to bank, so you should shop around to make sure you find the lowest fees and the best benefits. When shopping around, consider introductory offers, interest rates for both savings and checking accounts, interest rates for lines of credit, transaction fees, early termination fees, and minimum account balance fees. When choosing a merchant services account, take into consideration the discount rate, transaction fees, Address Verification Service (AVS) fees, ACH daily batch fees, and monthly minimum fees.
Payment processing companies are an increasingly popular alternative to traditional merchant services accounts, and sometimes provide extra functionality, like accessories that let you use your phone to accept credit card payments.
Set Up Accounting System
Once you have your bank account set up, choose an accounting program to make sure your books are organized.