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Part of Corporation formation: roles and liability basics
Corporation formation mistakes that surface only years later
Ten corporation formation mistakes that surface years later, from equity promised but never issued to a public record nobody updated after an officer left.
The most damaging corporation formation mistakes are not filing errors. Filing errors get bounced by the office and fixed the same week. The costly ones are the omissions that nobody notices for years, because a corporation with no record still looks exactly like a corporation with a good one until somebody asks.
Ten of them, in the order they tend to appear.
What to take away
- The most expensive mistakes are made after the filing, in the governance that nobody has time for.
- A share issued in an email, a decision made without a resolution, and a bank account opened before the board authorized anyone are the three that surface in every later dispute.
- Anything to do with tax classification is a mistake of doing it alone. The conditions are the IRS's and the fit is an accountant's judgment.
- A corporation you will not maintain is worse than a simpler form you will.
1. Treating the filing as the finish
The certificate arrives and people assume the work is done. At that moment the corporation has no bylaws, no properly appointed directors, no issued shares, and nobody authorized to sign anything.
After the certificate arrives
- Adopt bylaws
- Appoint directors
- Issue shares
- Authorize signers
Each is a step after filing; skip them and the entity exists but cannot show who may act for it.
2. Promising equity instead of issuing it
Somebody is told they have ten percent. No shares are issued, no register is updated, nothing is approved by the board. Two years later the promise is either a dispute or a gift with tax consequences nobody planned. Ownership is a register entry, not a sentence in a message. If shares are transferred subject to vesting or another substantial risk of forfeiture, a Section 83(b) election may be relevant and generally must be filed within 30 days after the transfer; it does not turn an unissued promise into issued shares.
3. Confusing authorized shares with issued shares
The Articles of Incorporation (called a certificate of incorporation or, in some states, a certificate of formation) name the number of shares the corporation is authorized to issue. That is not the number that exists, and treating the two as the same produces a share register that does not reconcile with anything. It is one of the first things a buyer or an investor checks, and it is tedious to unwind years later.
Authorized vs issued shares
Authorized
- What it is
- May be issued
- Where it lives
- Formation document
- Who checks
- Buyer, investor
- If confused
- Register won't reconcile
Issued
- What it is
- Actually exists
- Where it lives
- Share register
- Who checks
- Buyer, investor
- If confused
- Register won't reconcile
4. No record of decisions
Directors decide, and nobody writes it down. The absence is invisible until a bank, a lender, a claimant or a buyer asks who authorized something. A minute written on the day is a fact. A minute written two years later, from memory, is an argument.
5. Mixing money
The corporation's account pays a personal bill because it was convenient. That behavior is most often cited when someone argues the corporation and its owner were never separate, and it is entirely avoidable.
The SBA's description of what a business account is for is in its guidance on opening a business bank account. It is a fair statement of the discipline.
6. Signing in your own name
Contracts signed without stating the corporation and the capacity you sign in. The signature block should name the corporation, then you, then your office. It takes one extra line and it is the difference between the corporation being bound and you being bound.
Signature block: who is bound
Wrong
- Line 1
- Your name
- Line 2
- Nothing else
- Line 3
- Nothing else
- Result
- You are bound
Right
- Line 1
- Corporation name
- Line 2
- Your name
- Line 3
- Your office
- Result
- Corporation is bound
7. Choosing a tax classification from a comparison table
An election gets made because a video, a forum, or a table said it saves money. Nobody checked eligibility conditions or timing, and nobody modeled how the owner gets paid.
Eligibility conditions are set out on the IRS's S corporation eligibility pages. An eligible corporation elects S corporation tax treatment by filing IRS Form 2553. The deadline is generally 2 months and 15 days after the start of the tax year for which the election is to take effect; for a newly formed corporation, that tax year usually begins on the formation date. Late-election relief may be available. Whether any of it fits your numbers is an accountant's answer, not a page's.
8. Letting the public record go stale
The address changes, the officers change, and the person who receives legal papers moves away, yet the filing still says what it said on day one.
The address changes, the officers change, and the registered agent—the person or business designated to receive legal papers—moves or stops serving, yet the state record still says what it said on day one. The Secretary of State or Division of Corporations, depending on the state, maintains that record. Required annual reports and any state franchise-tax filings help keep it current; update the agent, address, and any officer information as the state requires. Which entries need updating, and when, is covered in keeping the filing current. Who that contact is meant to be is covered in the agent of record.
9. Running two states without noticing
Work is done, or people are hired, in a state where the corporation is not registered. This is a foreign qualification issue: a corporation doing business in another state may need to register there, often by applying for a certificate of authority through that state's Secretary of State or Division of Corporations. Each state defines for itself what counts as doing business there, and the way to find that definition is described in dealing with the filing office.
10. Abandoning rather than closing
The business stops trading and everyone walks away. But the corporation does not stop existing because trading stopped; recurring obligations continue until it is properly wound up. Follow the applicable state's business corporation law and file Articles of Dissolution, or the state's equivalent, with its Secretary of State or Division of Corporations. For federal tax purposes, a corporation generally must file IRS Form 966 within 30 days after adopting a resolution or plan to dissolve or liquidate. The IRS keeps its own list of federal steps under closing a business.
Walking away is the most expensive way to end one. The cost arrives years later attached to somebody's name.
What the ten have in common
Eight of the ten are omissions, not actions: nothing warns you, no letter arrives, and the entity keeps looking healthy.
A scheduled review that asks the boring questions is the only reliable defense. The honest test of whether a corporation suits you is whether you keep that appointment. If no, revisit the comparison in choosing a form before you build the machinery.
Common questions
Which one is most common?
Number four, by a distance. Almost nobody writes minutes for a small corporation, and almost everybody wishes they had the first time something is contested.
Can these be repaired later?
Most of them, at increasing cost. Records can be reconstructed and ratified, registers can be corrected, filings can be updated. What cannot be repaired is a document that had to exist at a particular moment, and buyers and investors do notice the difference.
Is any of this different for a single-shareholder corporation?
The disputes go away. The evidence problem gets worse, because there is nobody to corroborate what was decided. If anything, the record matters more.
How often should the review happen?
Once a year covers most of it, with an extra look whenever ownership, officers, address or states of operation change. Those four events cause most of the drift.
Does a filing service prevent any of these?
It prevents filing errors. Nine of the ten above happen after the filing and outside anything a service is doing for you, and no service takes responsibility for them.
