Business Entity Formation

A US business entity is a legal person separate from its owners. Forming one is mostly mechanical — a single state filing, an IRS number, a registered agent — but the choice of entity type and home state determines tax treatment, liability exposure, paperwork burden, and what an investor or acquirer will accept later. This guide covers the choice and the mechanics.

Why form an entity at all

Two reasons. First, liability: an entity isolates business debts and lawsuits from the owners' personal assets. A sole proprietor or general partner is personally liable for everything the business does; an LLC or corporation owner generally isn't, absent personal guarantees or veil-piercing. Second, structure: external investors, payment processors, lenders, and many enterprise customers will not transact with an individual. They expect a counterparty that exists in a state registry.

If you have no revenue, no employees, no contracts, and no assets to protect, you can defer formation. The minute you have any of those, the math shifts: the cost of formation (a few hundred dollars and an hour of paperwork) is small compared to one lawsuit, one tax notice, or one customer that won't sign with a person.

The five entity types

Sole proprietorship

The default when an individual conducts business without forming anything. No formation filing. The owner reports business income on Schedule C of their personal Form 1040 and pays self-employment tax. The owner is personally liable for all business obligations. There is no separate legal person; contracts, lawsuits, and bank accounts run through the individual.

General partnership

The default when two or more people conduct business together without forming anything. No formation filing required (though most states allow a Statement of Partnership Authority). Each partner is personally liable for all partnership obligations and for the acts of the other partners within the scope of partnership business. Income passes through to partners on Form 1065 (partnership return) and K-1s (per-partner statements). Universally considered a bad default; if two people are going to work together long-term, an LLC or corporation is almost always better.

LLC (Limited Liability Company)

A creature of state statute that combines pass-through taxation (by default) with limited liability. Owners are called members. Formation: file Articles of Organization (or Certificate of Formation, depending on state) with the Secretary of State. An LLC is tax-flexible: by default a single-member LLC is a disregarded entity (income on the member's Schedule C), a multi-member LLC is taxed as a partnership, and either can elect to be taxed as a corporation (S or C) by filing Form 8832 and/or Form 2553. Owners are not personally liable for LLC debts beyond their capital contribution, assuming corporate formalities are maintained.

S-Corporation

Not an entity type — an IRS tax election. An LLC or corporation files Form 2553 to be taxed under Subchapter S. Income passes through to shareholders, who report it on Schedule E. The advantage: owners who actively work in the business can split their income between salary (subject to payroll tax) and distributions (not subject to self-employment tax), often saving on FICA. Restrictions: no more than 100 shareholders; only one class of stock; shareholders must be US citizens or resident individuals (with limited exceptions); cannot be owned by most entities. These restrictions make S-Corp election incompatible with venture financing.

C-Corporation

The default tax treatment for state-law corporations. The entity pays its own tax (currently 21% federal). Distributions to shareholders are taxed again as dividends — the "double taxation" problem. C-Corps have no shareholder restrictions, can issue multiple classes of stock, and can have unlimited shareholders including funds, foreign persons, and other entities. This is the form expected by venture capital investors, by IPO underwriters, and by most M&A acquirers buying stock. Delaware C-Corp is the standard for venture-funded startups.

Other forms

Limited Partnership (LP) — one or more general partners with personal liability, plus limited partners with passive investment and no liability. Used for investment funds and real estate. Limited Liability Partnership (LLP) — partnership form available in most states for licensed professionals (law, accounting), shielding each partner from malpractice liability of the others. Professional Corporation / PLLC — entity forms required in some states for licensed professionals. Benefit Corporation / B-Corp — corporate form available in most states that codifies a public-benefit purpose; do not confuse with the third-party B Lab certification of the same name.

Choosing among them

Three questions narrow this quickly.

1. Do you plan to raise venture capital? If yes: Delaware C-Corp. Every standard VC term sheet assumes this. Forming as anything else and converting later costs $5,000–$25,000 in legal fees and often triggers tax. If no: skip to question 2.

2. Will the business generate enough profit to make S-Corp tax savings meaningful? Rough rule: the savings from S-Corp election start to exceed the added payroll and filing costs once owner-operator profit reaches roughly $40,000–$60,000 per year. Below that, the payroll setup is administrative overhead with little benefit. Above that, an LLC with S-Corp election (or a corporation with S election) typically beats a pass-through LLC on tax.

3. Multiple owners with different roles or capital contributions? Use an LLC with a custom operating agreement. LLCs allow flexible allocations of profit, loss, and management rights that corporations don't. Two equal founders with one putting in money and the other working can structure the LLC accordingly; in a corporation everything flows from share ownership.

For most small businesses without VC plans, an LLC is the default, with S-Corp election added once profit justifies it. For venture-funded startups, Delaware C-Corp from day one. For professional practices, the state-required form (PC, PLLC, LLP). For single-owner side businesses with no revenue, you can stay a sole proprietor until something changes.

State of formation

You can form a business in any state. The choice has three consequences: which state's law governs the entity, which state's annual fees and franchise taxes you pay, and where you can be served with lawsuits without additional filings.

Form in your home state if you operate primarily there, have no plans for outside investment, and want to minimize compliance. Forming out of state means you'll have to register as a "foreign" entity in your home state anyway, paying both states' fees.

Form in Delaware if you plan to raise institutional capital, have multiple founders or shareholders, or want the predictability of Delaware's corporate case law. Delaware's Court of Chancery is the most experienced corporate court in the country, with decades of precedent on fiduciary duty, mergers, and shareholder disputes. The downside is annual franchise tax (calculated on authorized shares; can be $400–several thousand if not properly configured) and the need to foreign-qualify wherever you actually operate.

Wyoming, Nevada, and South Dakota are marketed for "asset protection" and tax benefits. The supposed advantages are mostly marketing. If you live and work in California, forming a Wyoming LLC does not free you from California's $800 minimum franchise tax or California law — you'll foreign-qualify in California and pay both. The structures that do work for asset protection (trusts, multi-entity arrangements) are advanced planning, not default formation choices.

Filing the formation documents

Mechanics are similar across states.

1. Name check. The Secretary of State's website lists existing entity names. Yours must be distinguishable. Most states require a designator: "LLC", "L.L.C.", "Limited Liability Company" for LLCs; "Inc.", "Corp.", "Corporation" for corporations.
2. File formation document. Articles of Organization (LLC) or Articles of Incorporation / Certificate of Incorporation (corporation). Submitted online in most states. Required fields typically include: entity name, principal address, registered agent name and address, organizer/incorporator signature, and (for corporations) authorized shares.
3. Pay filing fee. Ranges from $50 (Kentucky LLC) to $500+ (Massachusetts LLC) per state. Delaware corporation filing fee is currently around $90 plus tax based on authorized shares.
4. Receive stamped filing. Some states return it the same day online; others take 1–4 weeks for mail submissions. Expedited service is available in most states for an extra fee.
5. Adopt governance documents. For an LLC, an Operating Agreement. For a corporation, Bylaws plus an organizational consent of incorporator that appoints initial directors, who then adopt bylaws, elect officers, and authorize stock issuance. See Operating Agreements & Bylaws.
6. Issue equity. Corporation: stock to founders against payment (or services, with tax considerations) and file a notice of issuance if required. LLC: record member interests in the operating agreement.

EIN and federal tax setup

An Employer Identification Number (EIN) is the entity's federal tax ID, analogous to a social security number. You'll need it to open a bank account, hire employees, file taxes, and run payroll. Get it directly from the IRS at no cost using Form SS-4 or the online application at IRS.gov; the online application returns the EIN immediately if the responsible party has a US SSN/ITIN. Foreign-owned entities apply by fax or mail.

Tax classification elections come next. To be taxed as an S-Corp, file Form 2553 (Election by a Small Business Corporation) within 75 days of formation or by March 15 of the year the election is to take effect. To have an LLC taxed as a C-Corp, file Form 8832 (Entity Classification Election). To make an 83(b) election on founder stock subject to vesting, file within 30 days of issuance — this deadline is missed often and is not extendable.

Registered agent

A registered agent is a person or company designated to receive service of process (lawsuits) and official state correspondence on behalf of the entity. The agent must have a physical street address in the state of formation (and in each state where the entity is foreign-qualified) and be available during business hours. You can serve as your own agent if you have a physical address in the state and don't mind your address being public. Most multi-state businesses use a commercial registered agent service ($50–$300 per state per year) for privacy and reliability.

Foreign qualification

"Foreign" in this context means out-of-state, not international. An entity formed in Delaware that conducts business in California must register as a foreign entity with California's Secretary of State (file a Statement and Designation, appoint a California registered agent, pay California's $800 annual franchise tax). "Doing business" thresholds vary; generally, having employees, an office, or significant ongoing sales in a state triggers the requirement. Failing to foreign-qualify when required can void your ability to sue in that state's courts and trigger back-filing penalties.

Ongoing requirements

• Annual report. Most states require an annual or biennial filing listing officers/directors/managers and confirming contact info. Fees range from $0 to several hundred dollars. Missing it leads to administrative dissolution.
• Franchise tax. Delaware, California, Texas, and others impose a franchise or privilege tax independent of income. California's $800 LLC/Corp minimum is the most-cited example.
• Federal and state tax returns. Form 1120 (C-Corp), 1120-S (S-Corp), 1065 (partnership/multi-member LLC), Schedule C (sole prop/single-member LLC). State equivalents.
• Beneficial Ownership Information (BOI) reporting. Under the Corporate Transparency Act, most US entities are required to file beneficial ownership reports with FinCEN. Scope and deadlines have been litigated; check the current FinCEN guidance at fincen.gov before assuming the rule applies or doesn't to your entity.
• Corporate formalities. Annual meetings, written consents in lieu of meetings, separate bank accounts, signed contracts in the entity's name. These are what keep the liability shield intact.

Maintaining the corporate veil

Limited liability is conditional. Courts will "pierce the corporate veil" and hold owners personally liable when the entity is used as an alter ego — commingled funds, undocumented transactions between owner and entity, undercapitalization, ignored formalities, fraud. The practical safeguards: a separate bank account from day one; never pay personal expenses from the business account or vice versa; sign contracts as an officer/manager of the entity, not in your individual name; document loans between owner and entity with a note; hold the meetings and write the consents your governance documents require.

Veil-piercing is unusual but expensive when it happens. Most small-business judgments are collected against personal assets via personal guarantees on the business's debt (commercial loans, leases, vendor credit) rather than via veil-piercing. Reading every signature line and refusing personal guarantees where possible matters more than corporate formality theater.

Typical costs and timelines

• Formation filing fee: $50–$500 depending on state and entity type.
• Registered agent service: $0 (self) to $300/year per state.
• EIN: Free directly from the IRS. Third parties charging $50–$300 for this are reselling a free service.
• Operating agreement / bylaws: $0 with a template (acceptable for simple single-owner cases) to $1,500–$5,000 for attorney-drafted (recommended for multiple owners, vesting, or anticipated investment).
• State annual fees: $0–$800+ depending on state.
• Timeline: Same day to 4 weeks for the state filing depending on state and processing speed. EIN: immediate online. Operating documents: hours to weeks depending on complexity and negotiation.

Common mistakes

• Forming the wrong entity for the funding plan. An LLC raises money awkwardly; converting to a C-Corp later is doable but costs money and sometimes triggers tax. If venture capital is the plan, start as a Delaware C-Corp.
• Missing the 83(b) election. Founder stock issued subject to vesting is taxed on each tranche as it vests, at then-current fair market value, unless an 83(b) is filed within 30 days. For a successful company, the difference is enormous.
• Forming in Wyoming or Nevada to "save tax" while operating elsewhere. You owe your home state's tax wherever you live and work; the formation state doesn't change that.
• Authorizing too few shares. A corporation authorized for 1,000 shares cannot cleanly support a 10,000-employee option pool or split. Authorize 10,000,000 shares of common at incorporation as a default.
• Personal-guaranteeing everything. Banks, landlords, and major vendors will ask. Sometimes the only way to get the deal is to sign. Track which obligations have personal guarantees and renegotiate when leverage shifts.
• Commingling funds. Paying personal expenses from the business account is the single most common veil-piercing fact pattern.
• Ignoring foreign qualification. Operating in a state without registering there is fine until you try to sue someone in that state, at which point your case is dismissed and you back-pay every year of franchise tax and penalties.

FAQ

Do I need a lawyer to form an LLC or corporation? For a simple single-owner LLC, no. For multiple owners, vesting, anticipated investment, or non-standard ownership, yes — the formation documents will need to match the deal.

How long does it take? Online filing in fast states (Delaware, Texas, Colorado) can be same-day or 1–2 days. Slower states (California, New York) can take 2–4 weeks without expediting. EIN is immediate online.

Can I form an entity from outside the US? Yes. Non-US persons can own US LLCs and C-Corps; S-Corp eligibility is restricted. EIN application for foreign-owned entities is by fax/mail (no online option without a US SSN/ITIN for the responsible party).

What's the minimum capital required? Zero, in any state. The "stated capital" requirements that existed historically have been eliminated in modern entity statutes.

Do I need an EIN for a single-member LLC with no employees? Technically you can use your SSN. In practice, get an EIN: banks expect one, it preserves SSN privacy, and the IRS recommends it for any entity that may add employees.