Arizona law provides for corporate operations with a minimum amount of red tape. However, contrary to what most online incorporation services would have you believe, incorporation involves more than adding "INC" to the company name.

Advantages of Incorporating

Recognized advantages of and considerations for the corporate business structure are the limited liability of shareholders for business debts, the ability to generate capital by selling shares, the relative ease of transferring ownership interests and the perpetual existence of a corporation (the entity does not cease upon the death or withdrawal of an owner - shareholders may come and go without affecting its legal status).

A properly formed corporation exists as a legal entity, separate and distinct from the persons who own and manage it. For legal purposes, a corporation is treated as a person and is liable for its own obligations - owners are not liable business for debts. Incorporation and operation of the entity are governed by state law, the Articles of Incorporation and the corporations by-laws.

Incorporation in Arizona

Filing of formation documents. To incorporate a business, Articles of Incorporation are filed with the Arizona Corporation Commission with a Disclosure of Information form. Under Arizona law, articles of incorporation include the following information:

    • The name selected for the corporation must be distinguishable from the name of any existing corporation, limited partnership, or limited liability company which is authorized to do business in Arizona.

    • A statement of the character of the business the corporation will initially conduct. A corporation may conduct business beyond that which is stated in the articles.

    • The number of shares authorized to be issued. A corporations articles will usually authorize a greater number of shares than is intended to be issued in the initial capitalization. This provides flexibility to issue additional shares in the future without amending the article of incorporation.

    • The names, addresses, and signatures of the incorporator(s). Incorporators need not be shareholders of the corporation, nor Arizona residents.

    • The name and street address of the corporation's initial statutory agent and the street address of the corporation's known place of business if different from that of its statutory agent. Every Arizona corporation must have a statutory agent to receive service of process.

    • The name and address of each of the initial directors of the corporation.

The articles may also include other provisions not contrary to the law.

Mandatory organizational meeting. After filing the articles of incorporation, the directors must hold an organizational meeting to appoint officers and transact other pertinent business, including the adoption of bylaws.

The point to be recognized is the mandatory requirement to hold the organizational meeting so as to be considered a properly-formed corporation. Arizona Revised Statutes, 10-205, states: "After incorporation the board of directors shall hold an organizational meeting at the call of a majority of the directors to complete the organization of the corporation by appointing officers, adopting bylaws and carrying on any other business brought before the meeting".

Even though the corporate existence begins when the Articles of Incorporation are filed, a failure to observe this statutory requirement may destroy the protection and special privileges of the corporation.

Bylaws must be adopted at the meeting. The bylaws set out the rules regulating the internal affairs of the corporation, including rights of shareholders, directors, and officers. Bylaws must be consistent with Arizona law and with the articles of incorporation. They should not be complicated with intricate procedures for corporate operation, because a complex bylaw provision may become a trap for the unwary, rather than a useful guide to corporate management. However, the bylaws should be as extensive as necessary to insure that procedures for internal management are described.

Capitalization and Financial Structure

The sale of shares usually provides the primary source of capital for a corporation. The attractiveness of shares as an investment is an important advantage of incorporating. Generally, shares can be sold to any person at any time. An Arizona corporation may issue any number of shares, up to the maximum designated in its articles of incorporation. Payment for shares may be in cash, other property, or in services already performed for the corporation. Promissory notes and promises to perform future services are not allowed under Arizona law for the payment of shares.

Sale of stock. An Arizona corporation can issue no-par or par value shares of stock. The distinction between no-par value and par value stock relates to the value required to be paid for their purchase. No-par value share permit greater flexibility in allocating the amount received in exchange for the shares.

Shares with a par value may be issued only for the consideration expressed in dollars, and not less than the par value. This means that shares with a $5 par value may be issued for $10 if someone is willing to pay that amount, but in no case may they be issued for less than $5.

No par value shares may be issued for whatever consideration that is set by the directors of the corporation.

Debt financing. Another method by which a corporation can raise capital is to contract for varied types of debt financing, whereby the corporation borrows money from outsiders who are willing to lend funds. Unlike shareholders, these creditors do not acquire an ownership interest (shares of stock) in the corporation. Their interest-bearing loans are generally considered to be a more conservative investment than purchasing stock, because the corporation is obligated to repay a loan from a debt investor, while there is no obligation to repay the funds invested by a shareholder, who risks the loss of his investment. Debt investors rank ahead of stockholders in payment priority.

Management and Control

Management by directors. Corporations are managed by directors, and by the officers appointed by the directors. Directors are in charge of determining corporate policy, managing business affairs and selecting and supervising officers who handle detailed business matters. Directors need not be shareholders of the corporation nor Arizona residents unless the articles of incorporation or bylaws so provide. It is permissible for a director to be a shareholder and an officer.

Arizona revised statutes 10-801 states the business and affairs of the corporation shall be managed under the direction of its board of directors, subject to any limitation set forth in the articles of incorporation. Thus, the board of directors of an Arizona corporation is an autocratic governing body of the corporation, responsible for management of the shareholders' enterprise.

Role of shareholders. Since directors act as the primary governing body of the shareholder owned business, it is only fair that the shareholders are entitled to elect the directors. The initial directors of a corporation are named in the Articles of Incorporation. They will serve until the shareholders meet to elect their successors. The election should occur at each annual shareholders meeting. A shareholder has the right to vote the number of shares they own, multiplied by the number of directors to be elected. A shareholder may cast all of their votes for one candidate or allocate votes among the candidates. This is known as "cumulative" voting and allows shareholders to elect directors in proportion to the percentage of stock they own.

Meetings of the board of directors can take place in Arizona, or outside of the state. Meetings may also be held telephonically. Rather than holding a formal meeting, directors also may take action by unanimous written consent. Unless otherwise provided in the bylaws or articles of incorporation, a majority of directors constitutes a sufficient number of directors, or "quorum," necessary for the transaction of business in a meeting.

Distributions

Profits are distributed to shareholders in the form of dividends and in proportion to their ownership share. A corporation may pay dividends in cash, in property, or in its own shares. Distribution may not be made if the corporation would not be able to pay its debts in the normal course of business.

Limited Liability of a Corporation

One of the most attractive benefits of incorporation is that investors risk only the amount of their investment. A shareholders personal assets are insulated from corporate debts. This protection of limited liability is usually the primary purpose for incorporating.

The limited liability theory of a corporation is well established in court decisions throughout the United States. However, a court may disregard the corporate entity, and hold principals personally liable for debt if shareholders or directors neglect to comply with statutorily required formalities such as the requirement to hold an organizational meeting of directors, or failure to hold annual shareholders meetings. Other typical abuses of corporate formality which may cause a court to "pierce the corporate veil" include failure to keep books and financial records of the corporation, or neglecting to distinguish personal assets from corporate assets.

The small businessman, who has formed a corporation for its limited liability benefits is most vulnerable to this piercing of the veil. If he commingles personal and corporate funds, neglects to hold formal meetings to document corporate decisions, fails to hold an organizational meeting or annual shareholders and directors meetings, then his corporate protection is weak.

Arizona courts are reluctant to grant relief to corporate creditors under the theory of piercing the corporate veil except in circumstances where legal formalities are not adhered to. By paying attention to record keeping formalities and documenting required meetings, the protection which incorporation provides to business principals can be maintained.

Tax Considerations

Corporations are treated as a taxable entity, separate and apart from its owners. A corporation computes its taxable income or loss each year and pays tax at the corporate level on its taxable income.

After payment of income taxes by the corporation, shareholders pay individual income tax on dividends, if any are distributed by the corporation. Consequently, corporate profits are taxed twice, once when earned by the corporation and a second time when distributed to the shareholders. This is widely referred to as "double taxation".

Corporate level income taxes may be avoidable by filing a special election under Subchapter S of the federal tax code. A corporation qualifies for "S Corp status" by filing an elective with the internal revenue service and by meeting certain criteria.

Record Keeping Requirements

Arizona corporations are required to file an annual reports with the Corporation Commission. The annual report includes the following information:

• The name of the corporation and the state where it is incorporated;
• The address of the corporation;
• The name and address of the statutory agent;
• The address of its principal office;
• A statement of the character of the corporation's business;
• The names and addresses of the directors and officers;
• The number of authorized and is sued shares;
• The name of each shareholder who holds more than 20 percent of any class of shares;
• A statement of the corporation's financial condition.

Additionally, an annual financial report must be provided to shareholders. All corporations are required to keep appropriate accounting records, as well as minutes of meetings of shareholders and directors.

Conclusion

The primary benefit of incorporating is the limited liability protection to the corporations shareholders and directors. Arizona law is designed to make it relatively simple to incorporate, however, there is more involved with incorporation than adding an "Inc." to the company name. Adherence to ongoing statutory formalities is required to maintain the limited liability qualities resulting from incorporation. If these formalities are not followed, corporate protection is weakened.

Disadvantages should be considered before you incorporate. The formalities inherent to operating a corporation and double taxation of business profits may make a limited liability company a more attractive business organization, especially for smaller companies.