How to Form a California Close Corporation
The attorneys of Theta Law Firm are familiar with the formation, maintenance, and dissolution of various business entities in California. For advice on how to form your business or other legal questions relating to your business, please feel free to give us a call or send us an email.
The following is a brief overview of the steps that need to be taken to form a California "close corporation." The California Corporations Code allows for the creation of a statutory close corporation. Qualifying businesses can form a California close corporation to avoid some of the formalities applicable to California Corporations generally. Shareholders are given more direct control over the corporation. The reduced requirements for close corporations makes it harder for creditors to go after the personal assets of shareholders. In some circumstances, the failure to comply with certain corporate formalities cannot be used against shareholders of California close corporations (whereas they can be with regular corporations).
Keep in mind that before forming a business entity, you should consider whether forming a California close corporation (as opposed to other possible business entities such as LLC, LLP, etc.) is the best fit for your business.
More about California close corporations and forming other California business entities can be found here: www.thetafirm.com/articles.
Step 1: File the Articles of Incorporation with the California Secretary of State (required)
The first step in forming a corporation is filing the Articles of Incorporation with the California Secretary of State. The Articles of Incorporation form must include: (1) the corporation's name, (2) the corporation's purpose, (3) the number of shares that the corporation is able to issue, (4) the corporation's street address and mailing address, and (5) the name and address of the corporation's registered agent for service of process.
In addition, for close corporations in particular, the Articles of Incorporation must also state how many shares the corporation is authorized to issue (that number cannot exceed 35). It must also specifically state that the corporation is a close corporation. A form for the Articles of Incorporation of a California close corporation can be found on the California Secretary of State's website here: http://www.sos.ca.gov/business/corp/pdf/articles/arts-cl.pdf. You can use this form or create your own.
Name selection: The name you choose for your corporation must be available. You can check the California Secretary of State's website for business entity names that are taken by going here: http://kepler.sos.ca.gov/. For close corporations, the name must include the words Corporation, Incorporated, or Limited (or their abbreviations). (See Cal. Corp. Code section 202.) The corporate name can be reserved by filing a Name Reservation Request Form and paying a $10.00 fee. That form can be found here: http://www.sos.ca.gov/business/be/name-availability.htm. You can also search nationwide through the US Patent and Trademark Office in order to avoid any possible trademark issues, which you can do at http://www.uspto.gov/trademarks/index.jsp.
Registered agent for service of process: California law requires corporations to designate one agent for service of process in the state. This is the individual or entity that will accept receipt of lawsuits on the corporation's behalf if it is sued. A corporation may not serve as its own agent for service of process in California, but the agent can be affiliated with the corporation. You can have either a corporate agent, or an individual agent. Individual agents must reside in California. Corporate agents must file with the California Secretary of State's office a Certificate under California Corporations Code section 1505, which can be found here: http://www.sos.ca.gov/business/corp/pdf/amendments/corp-1505.pdf. For a list of businesses that serve as registered agents, go here: http://www.sos.ca.gov/business/private-service-companies.htm/.
Step 2: Prepare Corporate Bylaws
Bylaws set forth the rules of operation for a corporation. They are not required to be filed with the California Secretary of State, but virtually every California corporation has them. The corporate bylaws usually address issues like the size of the board of directors, how the board of directors functions, the method and term of their election, the existence of corporate offices, how and when shareholder meetings are held, and other such issues. The bylaws are like a contract between the shareholders and the corporation.
It is best to maintain corporate bylaws because they establish clear operating rules, which can help avoid disputes down the line.
It is also advisable to maintain all of your corporation's important documents in one organized binder at your place of business. You should include the minutes of meetings, stock certificates, stock certificate stubs, and other corporate records. There are businesses that specifically prepare pre-made corporate binders for corporations.
Step 3: Appoint the Corporation's Directors (required)
The incorporator should appoint the initial corporate directors. The incorporator should prepare the Incorporator's Statement form, which shows the names and addresses of the initial directors (the statement does not need to be filed with the Secretary of State). The directors can also be appointed in the articles of incorporation.
Note that corporations in California must have at least three directors on their board unless the company has less than three shareholders. In that case, the number of directors must not be less than the number of shareholders.
Step 4: Hold a Board of Directors Meeting (required)
The close corporation should hold its first board of directors meeting. At the meeting, the board of directors can adopt bylaws, appoint corporate officers, authorize the issuance of stock, adopt an official stock certificate form and corporate seal, establish the corporation's fiscal year, and other tasks. If the corporation is an S corporation, the board of directors should approve the election of S corporation status.
The board of directors' actions must be documented in the corporate minutes. Corporate minute forms usually come with corporate kits that most corporations purchase.
Step 5: Issue Stock (required)
A stock certificate is a document that shows the ownership of a corporation's shares. The shares are typically issued in return for some kind of contribution (cash, property, or services). That contribution is the initial operating capital of the corporation. The board of directors establishes the price of each share. It is often advisable to issue the stock in connection with a stock purchase agreement. After stock is issued, you can also hold your first shareholders meeting.
Close corporations in particular should also have a shareholder agreement executed. A shareholder agreement, also known as a "buy-sell agreement" or a "stock restriction agreement" is an agreement that addresses a variety of issues, including operation and management of the corporation. It also sets forth the circumstances under which a shareholder agrees to offer his or her stock for sale to the corporation/other shareholders. Properly drafted shareholder agreements will help reduce shareholder disputes and costly litigation.
If you are married and will be using community assets to purchase the stock, you may also need to have a spousal consent form signed.
Securities Law Considerations: The issuance of stock often implicates federal and state securities laws, which are very complicated. In California, assuming you qualify, you can file a Limited Offering Exemption Notice (LOEN), which is a notice that you are exempt from certain California securities laws under Cal. Corp. Code section 25102(f). With respect to federal law, if the corporation issues shares to 10 or fewer people who will actively participate in running the business, it typically qualifies for exemptions to securities registration requirements. To be safe, you should seek the advice of counsel on this issue.
In cases where founders' shares will vest over time, founders may also want to consider making a Section 83(b) filing with the IRS.
Step 6: File a Statement of Information (required)
Within 90 days of filing the Articles of Incorporation, the close corporation must file a Statement of Information, as well as pay the filing fee for it ($25 as of the date this was written). That form can be found here: http://www.sos.ca.gov/business/corp/pdf/so/corp_so200.pdf.
For domestic stock and agricultural corporations, the Statement of Information must also be filed every year thereafter during the applicable filing period. The filing period is the calendar month during which the original Articles of Incorporation were filed and the prior five calendar months.
Cal. Corp. Code § 1501 also requires that a corporation send an annual report to shareholders within 120 days of the end of its fiscal year. However, if the corporation has less than 100 shareholders and its bylaws waive the requirement, the requirement does not apply.
Step 7: Pay California Taxes/Fees (required)
California close corporations and foreign corporations operating in California must pay taxes to the California Franchise Tax Board (FTB).
What state taxes does a California corporation have to pay? As of the writing of this article, the annual state tax in California for corporations is the greater of 8.84% of the corporation's net income or $800. In other words, the annual minimum tax that corporations must pay is $800. This tax must be paid during the first quarter of each accounting period, even if the corporation is inactive, operates at a loss, or does not do any business in California. Additional payments may be necessary, so speak to a qualified tax professional.
Exemption to annual minimum tax during first year: for certain new corporations that qualify the tax is based on the income of the corporation during its first year (the annual minimum tax does not apply).
For more information, go here: http://www.taxes.ca.gov/corpC.shtml.
Does a California Corporation have to file a State Tax Return? Corporations must file a Corporation Franchise or Income Tax Return (California Form 100) by the 15th day of the third month after the close of its taxable year. S corporations must file the S Corporation Franchise or Income Tax Return (California Form 100S).
These forms can be found here: https://www.ftb.ca.gov/forms/.
Pay California's payroll tax: Corporations are subject to California's payroll tax if they pay more than $100 of wages (even if the president is paid the wages and there are no other employees) in any quarter of a calendar year. This will open your corporation up to numerous additional regulations/laws/requirements. For more information, see the California Employment Development Department (EDD) here: http://www.edd.ca.gov/.
Step 8: Satisfy Remaining Federal Obligations
California close corporations must of course also comply with federal laws in addition to California laws. For example, corporations must obtain a federal Employer Identification Number (EIN). Information about obtaining an EIN (which is fairly straightforward) can be found at http://www.irs.gov/businesses/small/article/0,,id=98350,00.html.
In general, corporations must pay federal taxes. S corporations, however, do not have to pay income tax. You should seek the advice of a qualified tax professional to determine your federal tax obligations.
How do I make my close corporation an S corporation? S corporations are simply corporations that have elected to be taxed as a pass-through entity. S corporations have many requirements that are beyond the scope of this article. In order to elect S corporation status, the corporation must submit Form 2553, Election by a Small Business Corporation, which can be found at the IRS website (or go here: http://www.irs.gov/uac/Form-2553,-Election-by-a-Small-Business-Corporation.) In addition, California S corporations must also file California Form 100S, which is the California S Corporation Franchise or Income Tax Return form. You should speak to an qualified professional to determine whether your close corporation can qualify for S corporation status.
Step 9: Obtain Local Business License and Comply with Local Laws (required)
Different localities have unique rules that apply to businesses within their jurisdiction. Cities in Southern California often require you to obtain a business license to do business in their city. This could be as simple as submitting a form to the city, or it could be much more complicated and require the approval of various local governmental entities.
For example, businesses operating in the City of Los Angeles are required to obtain a business license from the city. Forms necessary for doing business in the City of Los Angeles can be found at: http://finance.lacity.org.
In addition to obtaining the necessary business permit/license, the locality may also require you to pay certain fees and follow other rules.
Each locality is different, so it is best to consult with experience counsel on the subject before opening your doors. The attorneys of Theta Law Firm can help guide you through the web of laws at a low cost.
Additional information can be found at the CalGold Business Permits website: http://www.calgold.ca.gov/.
What about Corporations Formed in another State (Foreign Corporations)?
Close corporations formed outside of California must register with the California Secretary of State by filing a Statement and Designation by Foreign Corporation form, which can be found here: http://www.sos.ca.gov/business/be/forms.htm. The filing fee is $100. You must also file a Certificate of Good Standing from the state in which the corporation was originally formed (the certificate cannot be more than six months old). If the desired corporation name is taken in California, you will need to provide an assumed name.
As of January 1, 2013, foreign corporations registering to do business in California must provide the street address of the corporation's principal business office in California, if it has one.
More information can be found here at the California Secretary of State's website: http://www.sos.ca.gov/.
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