Planning to start a business or expand your operations in the US? Here’s what you should consider.
By Vivek Krisnaswamy, for Legal Corner LLP. Vivek is a final year student of NALSAR University of Law and will be graduating in 2021.
The views expressed here are not to be considered as legal opinion. You may not rely on this article as legal advice. You should reach out to me (chetana@legalcornerllp.com) if you are planning to consider incorporate or expand your existing business in the US so as to get legal advice that is specific to your business needs.
Whether you are looking for investors, trying to expand your operations, or gain credibility, incorporating is an important milestone while building a business. It has commercial, legal, and tax implications, and the process itself can be daunting. Consulting the right people will help you understand what you are getting yourself into and make the right decisions for your business.
If you have an existing company, you need to answer one crucial question before creating another legal entity. What kind of relationship do you want the new and old entities to have? Which one will be the parent entity, or do you wish to start a branch of your existing company? Answering this is a very technical process, considering the legal and accounting ramifications, and is best done with the help of your lawyers and CPAs.
Choosing how to structure your corporate entity is the first step in the incorporation process. Every type of entity has its own implications when it comes to matters like liability, reporting, ownership and taxation.
If you wish to keep things simple, retain shares and control of your company then it makes sense to incorporate as a Sole Proprietorship or a General Partnership. In the US, there is no need for state filing, and liability extends to the personal assets of the business owner(s).
However, there are three other options that are structured in a way to allow for exponential growth of your business and reduce personal liabilities: C Corporation – General Stock (C Corp), S Corporation (S Corp) and Limited Liability Company (LLC). Here are some differences between them.
| Limited Liability Company (LLC) | S Corporation (S Corp) | C Corporation – General Stock (C Corp) | |
| How to form | Articles of Organization & Certificate of Organization need to be filed with State filing agency. | Articles of Association & Certificate of Incorporation need to be filed with State filing agency. Must elect S status through the IRS, additional filing required | Articles of Association & Certificate of Incorporation need to be filed with State filing agency. |
| Ownership | Owners are referred to as “Members” and ownership is divided by members as they see fit. Members do not own stock but they own “membership interests” in the company. | Owners are called “shareholders”, there can be up to 75 shareholders, and their ownership is represented by the number of shares they possess. | Owners are called “shareholders”, there can be an unlimited number of shareholders, and their ownership is represented by the number of shares they possess. |
| Can foreigners be owners | Yes | No | Yes |
| Liability | No personal liability unless a member secured a debt with a personal asset. | No personal liability of shareholders. Officers can be held liable in limited circumstances. | No personal liability of shareholders.Officers can be held liable in limited circumstances. |
| Tax | Taxed Once – Pass-Through taxation i.e. profits are passed through the members and reported on their personal tax returns; business is not taxed. | Taxed Once – you have a choice to opt for pass-through taxation or more conventional corporate taxations | Double Taxation – both the corporation and shareholders’ earnings are taxed |
| Management | There is no requirement to hold Annual General Meetings (AGMs). Managed by the Members. | AGMs must be held, and the Directors and officers as elected by the shareholders, manage the day to day. | AGMs must be held, and the Directors and officers as elected by the shareholders, manage the day to day. |
| Other | There are a few retirement plans/employee stock options that are only available to c-corps. |
Restricting foreigners from owning shares eliminates S Corp as an option for businesses that have or could potentially have foreign investors. LLCs are not suitable for those who desire to diversify ownership into stock options or for those who are averse to the risk of a pass-through taxation system. These are just a few considerations that make C-Corps the most popular legal structure for investment- heavy businesses and non-US companies looking to enter the US market1.
After deciding the form of incorporation, one must decide in which State to incorporate. Every one of the United States has its own specific regimes around tax, reporting, business and legal regulations and procedures. The main things to consider here are where you intend to operate your business, and the corporate law history, on-going reporting requirements, and the levels of tax levied in a State. Often, we find that companies incorporate themselves in the state of Delaware because it has a dedicated court of chancery for resolving corporate disputes, it doesn’t tax income earned from intangible assets and offers quite a bit of flexibility and privacy an organization. However, it is important to carefully consider incorporating here as the regime may not be suitable to all.
Though we’ve just said how each state has its own procedure, you can generally formulate the incorporation process into four steps2 –
- Select or reserve a unique business name that is not already in use
- File your articles of incorporation with the appropriate authorities and pay requisite fees
- Establish and maintain a registered agent. A registered agent must be physically residing in the state of incorporation and must have a registered office located in the state of incorporation.
- Register with the local tax authorities and abide by their requirements
You must apply to obtain a federal Employer Identification Number as soon as you incorporate and then open a business bank account. You have to be careful during the incorporation process, understand how much authorized share capital you should have, how much par value you should designate, if you should have only one class of shares or designate multiple classes of shares (common and preferred stock). Extra steps like this make consulting lawyers essential during the incorporation process. Any slip up while completing these tedious steps could open the doors to fines or other consequences that can have a negative impact on your business.
If you have any questions regarding the incorporation process, please email me at chetana@legalcornerllp.com . I will be happy to set up a free consultation.