After incorporating a business or forming an LLC, prepare yourself for ongoing compliance requirements. Failing to regularly meet ongoing requirements in a timely manner can have big consequences for small businesses.
Understanding internal requirements
- Business compliance requirements fall into two categories: internal and external. Internal requirements are actions that must be taken within the corporation or limited liability company by the directors and shareholders or members and managers, respectively. Although they are the most commonly overlooked, internal requirements must be documented as part of company records. It may be necessary to present these records when selling the company or in the event of a lawsuit.
- Corporations. Corporations (both C corporations and S corporations) have the strictest internal requirements, including holding initial and annual director and shareholder meetings, adopting and maintaining updated bylaws, issuing stock to shareholders, and recording all stock transfers.
- LLCs. While it’s not required for an LLC, it’s recommended that you maintain an updated operating agreement, issue membership shares, record all membership interest transfers and hold annual meetings of members and also of managers, if the LLC is manager-managed.
- Compliance kit. Many small business owners use a compliance kit to organize records. These include items such as sample bylaws or operating agreement, stock or membership interest certificates and transfer ledger, a corporate or LLC seal, and sample meeting minutes.
- Document templates. Templates for bylaws, operating agreements and meeting minutes can simplify the internal compliance process and are usually provided by your incorporation service provider if you incorporate online.
Understanding external requirements
External requirements are imposed by the state in which your business is incorporated and any state where it is registered to transact business (has undergone foreign qualification). State compliance requirements often include an annual state filing (annual report) and payment of a corresponding state fee. Here are some things to keep in mind as you address your requirements:
- Annual reports. Most states require corporations and LLCs to file an annual report (sometimes called an annual statement), which allows states to track formed or qualified corporations and LLCs. Other states require a biennial statement. In either case, states typically require that a fee be paid when statements are filed. These range from $10.00 to $300.00 or more.
- Franchise tax. Some states also have a franchise tax—a fee paid to the state for the privilege of operating as a corporation or LLC in that state. States employ different formulas, which may be based on business revenue or number of authorized shares and par value, for calculating this tax.
- Due dates for annual statements and franchise taxes vary by state. Some states connect due dates to the anniversary of the corporation’s or LLC’s formation or qualification. Other states set a particular due date for all corporation annual statements and another for all LLCs.
- Know the cost of these obligations. Because annual statements and franchise taxes represent ongoing requirements, you should research requirements prior to incorporating your business so that you can plan your budget accordingly.
- Initial reports. Finally, a few states such as California and Nevada also require initial reports/statements to be filed and fees to be paid within the months following incorporation. Your online incorporator or registered agent will let you know if your state has this requirement.
Facing the consequences
If a corporation or LLC is sued and unable to show it met all corporate or LLC formalities and state requirements, a judge can rule that the company has been acting more like a sole proprietorship or general partnership. This can result in “piercing the corporate veil” meaning that limited liability protection disappears and leaves individual owner(s) assets vulnerable if a lawsuit judgment is made against the company.
There are also consequences on the state level that can happen prior to piercing the corporate veil. If a corporation or LLC does not comply with a state’s annual or ongoing requirements, that company is no longer in “good standing.” Each state has different parameters for good standing, and many impose late fees and interest payments on outstanding annual statement and/or franchise tax fees. Being out of good standing long enough may lead to administrative dissolution, in which all benefits of being a corporation or LLC are lost.
Getting compliance assistance
Many online incorporators and professional registered agent service providers offer online compliance management tools specifically geared towards small business owners. These tools help make compliance with all formalities as easy and convenient as possible. If you formed your business as a corporation or LLC, be sure to take the time needed to ensure it stays compliant and keeps its valued entity status.