Frequently Asked Questions Regarding Incorporating a Business in California
Q: My start-up business will be based in California. Are there any benefits to forming a Delaware vs. a California corporation?
A: If you intend to do business in California (e.g. maintain an office or employees here), and you incorporate in another state, such as Delaware or Nevada, that new corporation will still need to qualify to do business in California. This in turn will make the new corporation subject to California’s minimum annual franchise tax (see the topic “What is the California “minimum annual franchise tax”?” elsewhere in these FAQs). Hence, despite the claims of numerous online “incorporate in Nevada; pay no California tax” storefronts, the latter are simply snake oil salespeople when one considers that their primary audience are California start-up businesses who will likely never have any substantive presence in Nevada. Experienced business attorneys like us help our clients avoid falling for such false claims.
In reality, the corporations law of Delaware and California are virtually the same today. Delaware used to be more advantageous in this regard, but California adopted substantially similar indemnification provisions more than two decades ago. The only advantage that Delaware may continue to have, is that Delaware courts have litigated more director & officer liability issues than the California courts, and therefore the case law under Delaware law may be slightly more developed than that of California.
Among the only reasons today for a California entrepreneur to opt to incorporate in Delaware, is a primarily cosmetic one. If the entrepreneur plans to solicit venture capital money, some Silicon Valley VCs still tend to like Delaware incorporations. The VC’s favor Delaware because there is a perception that the director and officer liability is more protective than California’s, that, and let’s face it, simple habit. As noted above, this is probably more perception than legal reality. Many California venture capitalists continue to believe that Delaware corporations are more favorable than California corporations. Since VCs will frequently require upon their financing of a start-up that they name directors and officers for the corporation, it is understandable why perceptions regarding any legal nuance that might lower their risk would die hard.
There are, however, significant differences in the ways in which California and Delaware tax the corporation. Delaware imposes a tax based upon the authorized number of shares of stock a Delaware corporation authorizes in its Certificate of Corporation. California does not impose such a tax, but does instead impose a “minimum annual franchise tax” on the corporation even if it does no business in a given year. The impacts of these different taxes will have different impacts on different corporations with differing long term goals for their capital structure.
The choice of jurisdiction of incorporation for the new start up business depends on number of practical, legal, and tax issues and should be arrived at only after a thorough consideration of these with our business attorneys and with your accountant.
Q: What is the California “minimum annual franchise tax?”
A: Corporations as well as other legal business entities, such as limited liability companies (LLCs,) organized in California or qualified to do business in California are subject to an annual minimum franchise tax for the privilege of being organized under the laws of (or doing business in) California and enjoying the protection of the laws of California. The current minimum tax is $800 per year. Note that the minimum tax applies even if the corporation or other subject business entity earns no income and even if the entity conducts no business. Information on current rates for the franchise tax can be obtained at www.ftb.ca.gov or by calling the Franchise Tax Board at 1-800-852-5711. See your accountant or tax advisor regarding payment of this and corporate income taxes.
Q: What is an “agent for service of process?”
A: Every corporation or other business entity doing business within California must designate a person on whom legal papers can be served by persons having to serve papers on the corporation or other business entity. This “agent for service of process” must be a natural person over 18 with a street address. The identity and street address of the business’s current agent for service of process must always be provided to the California Secretary of State. For corporations, the corporate agent is supplied in its annual “Statement of Information - Domestic Stock Corporation” required to be filed under California Corporations Code Section 1502. For LLCs, the company’s agent must be provided every two years (biennially) in the LLC’s biennial Statement of Information – Limited Liability Company.” Notwithstanding the fact that such statements must be filed with the Secretary of State on an annual or biennial basis, any change to the identity and/or address of the company’s agent for service of process, must be provided promptly to the Secretary of State in a new Statement of Information filing whenever such change occurs.
Q: What is an “S Corporation?”
A: An “S” Corporation is a corporation that has elected Subchapter S status for income tax purposes with the IRS. An “s corp” is not a type of legal entity per se. A California corporation might be a “c corp” (or any corporation that simply does not elect S status, and therefore is by default taxed on its own income by the IRS) or it might elect to become an “s corp” with the IRS. There are, however, specific rules imposed by the Internal Revenue Code for the qualification of corporations to be “S corporations.” Among these: an S corp cannot have more than 75 shareholders; it cannot have different classes of shares; it cannot have any shareholders that are not natural persons (i.e., it can’t have corporations, LLCs, ongoing trusts, or other entities as shareholders); all shareholders must legal permanent US residents, etc.) The IRS’s rules on S Corporations can be found here.
A simply stated explanation of S corporations vs. C corporations is that a “C corp” is taxed at the corporate level on its income and an S corp is not. An S corp, for IRS income tax purposes, is ignored, and the net profits of that corporation “flow through” to the individual shareholders. The shareholders must in turn claim their share of the corporation’s net profits on their individual tax returns. The shareholders’ share of net profits is determined strictly according to their pro rata share of the corporation’s outstanding shares of stock.
The decision of whether the newly incorporated California corporation should elect IRS Subchapter S status or not is one that should always be made in concert with us and with the corporation’s accountant. The founding shareholders should likewise consult with their individual CPAs to determine what effect the corporation’s S status will affect them from an income tax perspective.
Q: What is a “fictitious business name?”
A: A fictitious business name, also termed a “d.b.a.”, is not a legal entity at all but rather simply a filing that allows a person (which can be an individual or a legal entity, such as a corporation) to use a name other than the person’s legal name when doing business. These are typically filed in the California county clerk-recorder’s office where the business is located.
Q: Can a California corporation have only one individual filling all of the following roles: President/CEO, Treasurer/CFO, Secretary, Director, and sole shareholder?
A: Yes (provided it is not a non-profit corporation). Although the California Corporations Code requires that every corporation have, at a minimum, a President/CEO, Treasurer/CFO, and a Secretary as its Officers, and at least one director (only if there is only one shareholder, otherwise the minimum is generally three), one individual person is allowed to fill all of these roles. A corporation in California may have only one individual performing the roles of all officers and director of a valid California corporation.
Every California corporation must have a President/CEO, a Secretary, and a Chief Financial Officer/Treasurer. Any number of offices may be held by a single person unless the Articles or Bylaws provide to the contrary (note again, however, that this is not true for Nonprofit Corporations). The officers are typically appointed at your first meeting of the board of directors, or alternatively, by having the directors sign a resolution so appointing them (called an “Action by Unanimous Written Consent”). If we are retained to form a California corporation, will prepare either Minutes of the corporation’s first board of directors meeting appointing the officers or prepare an appropriate board resolution to do so in an Action by Unanimous Written Consent for the corporation’s board of directors to legally accomplish this. Note that the officers and directors of a California corporation must be elected annually at the corporation’s mandatory annual meetings of the board of directors and of the shareholders. The date(s) of these meetings are contained in the Corporation’s Bylaws. If our business lawyers maintain the corporation’s Minute Book, we will schedule these meetings, inform the officers and directors, and prepare the appropriate annual board and shareholder resolutions.
Officers serve at the pleasure of the Board. They are either reappointed or replaced at the corporation's annual meeting; however, if it is desired to replace an officer in the interim, this can be done by following the procedure in the Corporation’s Bylaws, or if they are silent under the procedure provided in the California Corporations Code.
Q: What is a “Statement by Domestic Stock Corporation?”
A: As required by California Corporations Code Section 1502, every year, a California corporation must file a Statement By Domestic Stock Corporation with the Secretary of State, setting forth the address of the corporation’s principal executive office (which must be a street address), the names and addresses of the President/CEO, the Secretary and the Chief Financial Officer/Treasurer, the names and addresses of the incumbent directors, and the type of business in which the corporation is engaged. The statement must also designate an agent for service of process. A newly organized corporation must file its first statement within ninety (90) days after the date of the incorporation.