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By incorporating your business, you have taken an important step towards protecting yourself from business-related liabilities.  The corporation is able to   protect you from direct liability for its business operations because it is a separate legal person under the law. But this protection, sometimes called the “corporate veil,” can be lost if your corporation is not treated properly.

Overview

To keep the “corporate veil” in place, you need to treat the corporation as a separate person in its day to day operations. For example:

  • The corporation’s  funds must be deposited in its own bank account under its own tax I.D.  number. All corporate expenses should be paid from the corporation’s bank  account with the corporation’s funds. It is essential to avoid commingling your personal funds with the corporation’s funds.
  • In general, the  corporation should not pay any of your personal expenses, such as rent, groceries, entertainment, etc. These should be paid from your personal bank account.
  • Before you withdraw money from the corporation’s bank account as compensation or shareholder distributions to yourself, be sure that the withdrawal complies with one  of the rules described in the next section.
  • All contracts  relating to the corporation’s business (such as leases, insurance policies, customer contracts, etc.) should be signed in the name of the corporation, not in your individual name. You will be personally liable for any contracts that you sign in your own name.
  • Title to the  corporation’s assets, including its intellectual property, should be in the corporation’s name.
  • Your website, signs, yellow pages listings, and promotional materials should all reflect  the corporation’s name.
  • All business cards should reflect the corporation’s name as well as the name of the individual officer or employee.

Withdrawing Corporate Funds

As a general rule, you may withdraw corporate funds for your personal use only as

  • Reasonable compensation for your services to the Corporation (which must be reasonable in relation to the services you actually performed),
  • Repayment of a loan that you made to the corporation, or Shareholder distribution based on your ownership interest in the corporation (i.e., a dividend). There are special rules that apply to shareholder distributions.
  • Until January 1, 2012, as a general rule, the corporation may make a distribution to its shareholders only to the extent that the distribution comes out of its retained earnings. (There is an exception to this rule if the corporation can meet a complex assets-to-liabilities test.)
  • After January 1, 2012, the corporation may generally make a distribution to its shareholders if (1) the distribution does not exceed its retained earnings, or (2) the value of the corporation’s assets immediately after the distribution would equal or exceed the sum of its total liabilities.

Taxes and Accounting

Your accountant will prepare the corporation’s annual tax returns and can assist you with the day-to-day tax and accounting issues that you may encounter.

Books and Records

The corporation must maintain its financial records in a commercially reasonable manner. You may want to retain your accountant or a bookkeeper to assist you with this task.

S Election

As you probably know, an “S corporation” is a corporation that has elected to be taxed under Subchapter S of the Internal Revenue Code. There can be some tax advantages to making the “S election” choice. The corporation itself will not pay income taxes.  Instead, the corporation’s shareholders will report the corporation’s profits and losses on their individual tax returns. Please note that the shareholders, you will have to pay taxes on the corporation’s income even if the corporation does not distribute any dividends. It is generally a good idea to make sure that the corporation has enough cash to distribute to the shareholders to cover these taxes.

To qualify for the S election, the corporation may have no more than 100 shareholders. With a few exceptions, each shareholder must be an individual who is a U.S. citizen or a permanent resident alien. If a disqualified person such as an LLC or a nonresident alien becomes a shareholder, the corporation will lose its election. This can result in adverse tax consequences.

Franchise Fee

The corporation must pay an $800 minimum franchise fee each year.

Payroll Tax Withholdings

If your corporation hires any employees, it will be required by law to withhold payroll taxes and FICA contributions for each employee. If your corporation fails to withhold these taxes, those persons who had the authority to make the contributions but failed to do so—i.e., the officers—will be personally liable for the full amount. Please contact your tax advisor with any questions you might have.

Employment Issues

If the corporation hires any employees, it will also be subject to an array of California and federal laws governing workplace safety, minimum wages, unlawful discrimination, and harassment, to name a few. It can be difficult to navigate these laws and regulations.

Insurance

The orporation needs to obtain insurance coverage in its own name. You should meet ith your insurance agent to discuss the corporation’s operations and ecommended coverage.

Securities

The ale or transfer of the corporation’s shares of stock is heavily regulated nder California and Federal securities laws. It is essential to comply with hese securities laws to minimize the risk of liability to the corporation and its shareholders.

Close Corporation Status

Unless the corporation has elected to be a “close corporation” under California law, it must hold annual meetings of shareholders and directors. If the corporation fails to hold these meetings, this could be used against it in an attempt to pierce the corporate veil.

Annual Statement of Information

The corporation is required to file an annual Statement of Information with the California Secretary of State together with a $25.00 fee. The Secretary of State will mail annual reminders to you. If you do not file the Statement of Information, the corporation may be suspended, meaning that it loses all of its corporate powers and must pay a fine to be reinstated.

Fraud Alert

The corporation may receive official-looking correspondence asking you to pay several hundred dollars to prepare and file your corporate minutes and annual statement of information. This is a fraud. The Secretary of State does not accept corporate minutes for filing—instead, corporate minutes (should you choose to have them) are kept in your corporate record book.

Business License

The Corporation may need to obtain a business license. Many municipalities provide licensing information and any required application on their municipal websites. Check your local municipality.

Conclusion

This is a rather brief overview on some of the critical aspects of forming and running a corporation. In particular, I’ve focused on what advantages you and your business could enjoy by designating your corporation as an S-corporation. If you have additional questions about whether your corporation should be designated an S-corporation or a different designation, I’d be happy to discuss this with you.

This is just a basic overview and is not legal advice specific to your situation. If you would like to speak with me about your situation, please email me at jcw@eastbaybusinesslawyer.com or call 925-327-1019.

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