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California Corporation

For California Corporation prices and State fees, please visit the costs page for forming a Corporation in California.

The decision to form a corporation in California should be an informed one, based upon where you intend to conduct your business, and what benefits you expect to extract for your business from its incorporation. More and more people are taking advantage of the benefits afforded by incorporating and this makes a lot of sense for the businessman or entrepreneur looking to take his business to the next level. If you intend to conduct most of your business in California, hold a physical address in California, and bank in California, then forming your corporation in California makes perfect sense.

A California corporation, like any other, is considered by law to be a legal entity separate from those who own or control it. This helps shield the individual shareholders from personal liability, and depending upon how it is formed, can provide certain beneficial tax advantages to the shareholders.

Forming a Corporation in California

As in any other state, a corporation is formed in California by filing the articles of incorporation with the Secretary of State, paying the necessary fees, establishing a resident agent, and implementing the corporate formalities. Once the corporation is formed, the shareholder (or shareholders) must determine who will comprise the Board of Directors (In California, a corporation may have a minimum of one shareholder and one director), and the Board must in turn decide who will hold the officer positions in the corporation.

Managing a California Corporation

California requires that all corporations have three officer positions: president, chief financial officer and secretary. These three positions may be filled by one person. If a California corporation has two shareholders, there must be at least two Board members. If there are at least three shareholders, then there must be at least three members on the Board. Since the Board is the governing body of the corporation, when there are three shareholders, a party owning the majority of the shares can still be outvoted on the Board, and important actions, such as removing a director, involves certain risks even when a founder has the votes to do so. Thus, it is imperative that the founder take selection of the initial Board quite seriously and that he or she makes careful selections.

Taxations of a California Corporation

A California corporation is a separate entity for tax purposes. Income taxed at the corporate level is taxed again at the shareholder level if any distribution is made in the form of a dividend. This is what is known as “double taxation,” and considered one of the pitfalls of a standard, or C, corporation. While this may be an issue when it involves a larger business or higher-gross companies that intend to have multiple partners or members, this is not normally a drawback with a closely-held corporation with few shareholders. The S Corporation election (via IRS form 2553) described below enjoys pass-through taxation by limiting the tax to the shareholder level, though it subjects all earnings to taxation whether or not distributed, and is limited to 75 or fewer shareholders. C-corporations can have an unlimited number of shareholders, are allowed to be U.S. and/or non-U.S. residents shareholders, and are taxed on net profits. A C-corporation can deduct employee medical expenses and insurance. Both C and S corporations may have a pension plan. Money paid into the pension plan is tax-deductible to the corporation and tax-free to the employee. The money inside of the pension plan can grow tax-free until withdrawn for retirement. The current maximum federal corporate tax rate is 35%. As of this writing, the current California corporate taxation rate is approximately 9%.

In the event of business collapse or failure, the losses of the initial investment of up to $1 million (at purchase price value) of common and preferred stock (so-called "Section 1244 stock") may be used under certain circumstances by shareholders to offset a corresponding amount of ordinary income in their federal income tax returns. (An individual may deduct, as an ordinary loss, a loss on Section 1244 stock of up to $50,000 in any one year [$100,000 on a joint return]).

Corporate Formalities

Once a your California corporation is formed, it is imperative that all of the corporate formalities are observed. Corporate formalities are formal actions that must be performed by a corporation’s director, officers, or shareholders in order to maintain the protection afforded by the formation of the Corporation. These are essential procedures that serve to protect the personal assets of a Corporation’s directors, officers, and shareholders.

  • Corporate Funds must be maintained separate and apart from Personal Funds.

    The corporate entity should have it’s own banking accounts (to include checking, lines of credit, etc.). Not keeping these funds separate, also known as “co-mingling,” can lead to increased scrutiny and potentially serious liability in the event of audit by the IRS and the endangerment of personal assets. It is a best practices procedure not to co-mingle funds.

  • Meetings of the Board of Directors’ must be held at least annually, usually following closely behind Shareholder meetings (also known as “Special Meetings”). All 50 states mandate a meeting being held at least once a year.

    These annual meetings should be used to approve transactions entered into by the Corporation.

    In lieu of attendance by any given Director, written consent must be provided by said Director (either in the form of a waiver in the absence of proper notice, or in the form of a proxy vote given proper notice) for any decisions made at these meetings.

    Meetings of the Shareholders, also known as “Special Meetings” can be held at any time.

    The Corporation’s Secretary is responsible for giving proper legal notice of these meetings, and for maintaining the necessary waivers, proxies, minutes, etc.

  • Corporate Minutes, or “notes of the meetings of the Board of Director’s or Special Meetings” are essential and are the official, legal record of such meetings.

    The Corporate Minutes are to be maintained in date order in the Corporate Minute Book, and can be a valuable asset in the protection of the Corporation’s directors’, officers’ and shareholders’ assets. Proper, timely maintenance of these minutes is essential in defending against audits by IRS and alter ego claims.

    Directors and Corporate Officers will at times seek legal counsel during annual meetings, and any discussions during these sessions are considered privileged conversations and protected by the legal doctrine of Attorney-Client Privilege. However, minutes taken of these conversations are considered part of the Corporate record and hence care must be taken, by the Corporate Secretary, to note when these communications occur by citing them in the Corporate Minutes as “Conversations by the members of the board of directors and legal counsel engaged in legally-privileged conversation at this point” instead of noting the actual conversation verbatim.

  • Written Agreements for all transactions should be executed and maintained.

    All transactions that involve real estate leases, loans (whether internal or external), employment agreements, benefit plans, etc. that are entered into by or on behalf of the Corporation must be in written agreement form.

Improper or untimely documentation of internal loans from a Shareholder to the Corporation, for example, may lead to IRS re-classification of repayment of the principal on said loan as a dividend, with the commensurate tax liabilities incurred by the Shareholder

It is imperative that executive compensation, capital asset acquisitions, etc. be timely and properly documented in these minutes. Failure t properly and timely documents these can potentially lead to tax liabilities on the part of the Directors, Officers, or Shareholders as a result of IRS “reclassification.” For example, the IRS may classify what they deem as “excessive, undocumented executive compensation” as a dividend by the corporation to the recipient, and hence not tax deductible by the corporation--this will lead to increased, unpaid tax liabilities.

We cannot stress highly enough that failure to observe and implement these formalities will serve to diminish and mitigate the protections offered by the formation of the Corporation and will allow outside entities (the IRS, creditors, claimants/plaintiffs, potential adverse litigants, etc.) to “pierce the corporate veil” and peer into the inner workings and assets of the Corporation, it’s Officers, Directors and Shareholders. When the formalities are observed, individual shareholders have personal liability only to the extent of their investment, i.e., what they paid for their shares.

Advantages of California Corporations

  • The shareholders (owners) of the Corporation are protected from liability when the business is sued
  • Perpetual Duration of the Company unless specified otherwise in the Certificate of Incorporation
  • The owners enjoy limited liability protection based upon the amount they have paid into their share of stock
  • The operations of a Corporation are not affected by the transfer of shares or death of a shareholder
  • Corporations may own property, sue, and be sued due to their status as a separate legal entity
  • Disadvantages of Corporations
  • Formal “Corporate Formalities” must be implemented in order to ensure adherence to local and federal rules, as well as to afford the protections offered by its status as a separate entity.
  • Registration with government registries

Once incorporated, there are a few helpful steps to take that can help one enjoy the benefits of the corporation. For example, the acquisition of a Federal Tax ID from the IRS is an essential step. If filing as an S-Corporation, the IRS form 2553 must be filed before the 16th day of the third month of the tax year that the election is to take effect, or at any time during the tax year proceeding the tax year the S-Corporation is to take effect. After receiving the Federal Tax ID number, the articles of incorporation, and the certificate that has been file-stamped by the government, a separate bank account should be established for the business, with the understanding that the “co-mingling” of personal and business funds should not occur. Care must be taken that any follow-up documents are filed with the state as required, such as the list of officers and directors, and that a secretary is assigned and held responsible for the Corporate Minutes. If required, make sure to get a business license in the county in which the company operates. It is sound advice to have a tax professional who is experienced in corporate accounting prepare the required tax filings. Below is a summary of important items to remember after your corporation has been delivered:

  • Obtain Federal Tax Identification Number
  • Make S-Corporation designation if desired
  • Open Company bank account
  • Assign a Secretary
  • File necessary follow-up documents such as a list of officers and directors, if required
  • Consult with a Tax professional at least annually

Forming a corporation in California is a great first step in taking your business to the next level. A corporation is the best alternative for you business if you expect your business to grow, especially in light of the employee incentive stock plans, its ease of accommodating outside investment, greatly reduced personal liability, and greater long-term liquidity for shareholders. A Savvy investor would review business model and position, and see the “inc.” after your business as a sign that the business is a serious, viable venture and worthy of his investment. This is a critical step towards making investors feel comfortable and give serious consideration towards investing capital in your enterprise!

California Corporation

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