Operating a California Corporation
By Matt Dickstein
The purpose of this Memorandum is to discuss certain procedures and
operations relevant to a newly-formed California corporation. The summaries
below are not a complete analysis of the areas discussed, rather they are
provided to give a basic understanding of the legal requirements which
California corporation should follow. Because this discussion is general in
nature, it should not be relied upon as complete information regarding any of
the matters discussed, but rather, should be used as a general guide. Please
feel free to contact me if you have any questions.
It is difficult to overstate the importance of maintaining the formal
integrity of the corporation. It is a legal entity independent of its
shareholders, officers and directors, and should always be treated as such. To
ensure that the benefits offered by the corporate form are maintained, not the
least of which, of course, is the protection of shareholders against the
imposition of personal liability for obligations incurred by the corporation,
the corporation should scrupulously observe the corporate formalities discussed
The holding of regular shareholders' and directors' meetings is an important
aspect of maintaining the corporation. All contracts entered into by the
corporation, including employment contracts, buy-sell agreements, loans, leases
and purchase contracts should be made in the name and on behalf of the
corporation. In addition, all important transactions concerning the
corporation's business should be approved by the board of directors, and that
approval should be reflected in the minutes of board meetings.
The following formalities should be observed in connection with the ongoing
operations of the corporation.
1. Shareholder Action. Under California law, shareholder meetings or
action by written consent should be held or taken at least once a year. Unless
otherwise provided in the articles of incorporation, the presence in person or
by proxy of persons entitled to vote a majority of the voting shares of a
corporation constitutes a quorum. In addition, shareholder action may be taken
by written consent of the shareholders without a meeting if the consent process
satisfies statutory requirements.
The principal order of business to come before the shareholders at their
annual meeting is the election of the board of directors. In addition, certain
fundamental changes in the corporation's form of operation require the consent
or approval of the shareholders. Such changes include amendment of the articles
of incorporation, sale of all or substantially all of the corporation's assets,
merger or consolidation of the corporation with or into any other corporation,
and the winding up and dissolution of the corporation.
2. Director Actions. Although day-to-day management of the corporation
is generally delegated to its officers, matters of general operating policy
should be considered and authorized by the board of directors. There is no
statutory requirement with respect to how frequently the board of directors
should meet; as a matter of sound practice, however, regular board meetings
should be held at least annually. In addition, a specially convened meeting of
the board may be called if action is required before the next regular board
meeting. Meetings may be held by a quorum of the directors in person or by
conference telephone, as long as all members can hear one another. In lieu of a
meeting, action by the board may also be taken by the unanimous written consent
of the directors.
Matters for which board approval should be obtained include the following:
Election of officers, setting of salaries of senior officers, and
declaration of bonuses (at least annually, typically at a meeting of the
board of directors immediately following the annual shareholder meeting);
Appointment of board committees;
Opening of corporate bank accounts and the designation and change of
corporate officers authorized to act as signatories;
Corporate borrowing and the concomitant giving of security;
Consummation of contracts for the acquisition, disposition or lease of
significant assets or services, or for the rendition of services outside the
corporation's ordinary course of business;
Policy decisions with respect to the construction of significant assets
or other projects which may require accumulation of surplus reserves and the
use of available cash;
Adoption of pension, profit-sharing, bonus and other employee benefit
Declaration of dividends or redemption of shares;
Amendment of the bylaws;
Review of financial statements;
Appointment of auditors;
Any action which requires the consent or approval of the shareholders,
including those shareholder actions described above; and
The issuance and sale by the corporation of additional shares which are
authorized by the articles of incorporation or the grant of options to
purchase such additional shares.
3. Distinction Between Officers and Directors.
Directors control the
corporation's policies, while officers are charged with the implementation of
those policies. A director may not delegate his or her authority. Thus, for
example, a director may not give his or her proxy to vote at a meeting of the
board of directors. An officer, on the other hand, may generally delegate
responsibility and authority.
Under California law, the corporation must have a president, a secretary and
a chief financial officer (treasurer), all of whom are chosen by the board of
directors. Any two or more offices may be held by the same person. The general
scope of the duties of each officer is outlined in the bylaws.
The officers of a corporation serve at the pleasure of the board of
directors. Even though an officer may have an employment contract which grants
certain rights to compensation, he or she may be removed from office by action
of the board, subject to any such continuing rights to compensation. Termination
of an officer as an officer or employee nevertheless raises serious issues of
labor law which should be considered on a case-by-case basis.
A director or officer may resign at any time. Acceptance of the resignation
is not necessary. A resignation is effective upon its delivery to the
corporation, unless stated to be effective at a future date. In the case of a
resigning director, the remaining directors may (unless the articles of
incorporation or bylaws otherwise provide) appoint a new director to fill a
vacancy. The shareholders may at any time fill a vacancy, amend the relevant
corporate documents or expand the board, or take action to remove
a director which is consistent with relevant corporate documents and corporate
4. Directors' and Officers' Responsibilities.
Both directors and
officers should be mindful of the following important duties and
Payment of salaries to employees.
Officers responsible for the
payment of salaries must see that the corporation pays those salaries.
Failure to do so may result in criminal penalties under the California
Labor Code. Many banks offer a "payroll service" to their customers; you
may wish to consider such a service for your corporation when the number
of employees so warrants.
Payroll taxes. All payroll taxes (including income tax
withholdings) must be promptly paid by the corporation. Failure to pay
may result in the imposition of civil or criminal liability on officers
and directors. We recommend that all payroll tax matters be handled with
care and with the guidance of an accountant where appropriate.
Loans to directors. If the corporation loans money to its
directors, any other directors approving such loans may be held
personally liable for any amounts which are not repaid, unless the loans
were approved in advance by a vote of the shareholders.
Duty to inspect. A director has the absolute right to inspect all
corporate books, records, documents and property. In fact, a failure to
exercise such rights might subject a director to liability for
negligence in the event the corporation (or its creditors) suffers a
loss by reason of the director's failure to exercise due diligence in
Officers and directors have a fiduciary duty to
the corporation and its shareholders. Because of the special duty of
loyalty imposed by this relationship, neither officers nor directors may
directly compete with the corporation, nor may they take for themselves
business opportunities which are in the corporation's current or
reasonably anticipated line of business.
Annual report to shareholders.
California law requires that the
accounting books and records, and the minutes of proceedings of
shareholders and board of directors meetings, be open for inspection by
any shareholder, director, or holder of a voting trust certificate.
Further, corporations are required to send an annual report to
shareholders not later than 120 days
after the close of the fiscal year. The annual report must contain a
balance sheet, an income statement of changes in financial position for
the fiscal year, and also must be accompanied by a report thereon by the
corporation's independent accountants or, if there is no such report, by
a declaration by an authorized officer of the corporation that the
statements were prepared without
an audit. This requirement can be waived in the bylaws by corporations
with fewer than one hundred shareholders. Since your corporation falls
into this category, I have waived this requirement in your bylaws.
Corporations with one hundred or more shareholders that are not
subject to federal securities reporting requirements also must comply
with additional disclosure requirements. These include describing any
significant transactions between the corporation and any director,
officer, or ten percent or greater shareholder.
Compensation of directors and officers.
A director is not
ordinarily entitled to compensation for services rendered as a director
unless such compensation is provided for by bylaw or corporate
resolution. The directors have the power to fix the salaries of
officers. In most instances it would
be prudent to submit elaborate compensation plans to the shareholders
and the directors for their approval or ratification.
Other duties. A director must be concerned with other sources of
liability, including the improper declaration of dividends or repurchase
of corporate shares, fraudulent entries in corporate books or reports,
and failure to supervise properly the operations of the corporation.
Compliance with applicable state and federal securities laws is an area
of particular importance for directors, as securities liability is often
asserted against directors.
5. Everyday Common Practice as a Corporate Entity.
To further ensure
that there is no confusion on the part of outsiders dealing with the new
corporation, the following steps should be taken:
All letterheads, bills, invoices, and other business forms used by
the corporation should reflect its full legal name as well as its
current address and telephone number.
The telephone numbers of the corporation should be listed under its
name with the telephone company and in all telephone and trade
The corporation's full legal name or fictitious business name should
appear on all signs in its building. Business cards should indicate both
the corporation's name and the employee's name.
Any existing contracts or leases should be transferred to the
corporate name, if permitted. Future contracts or leases should be
executed in the corporation's name, with the signature blocks clearly
identifying the signing party as an officer signing on behalf of the
It is the responsibility of the corporation's officers and directors to make
certain that customary accounting practices and auditing procedures are observed
by the organization in a proper and timely fashion. A corporation is also
generally required to pay various state and federal taxes as well as to withhold
or pay various employment taxes with respect to its employees. Accordingly, the
corporation should have an accountant who should be kept currently informed
regarding all of the corporation's business activities. If you do not yet have
an accountant I will be happy to recommend one.
Additional Post-Incorporation Matters
1. Stock Issuance. As a general rule, the corporation must obtain a
permit from the California Commission of Corporations before issuing stock.
Exemptions from the permit requirement are available for certain transactions.
Failure to comply with applicable securities laws can result in rescission of
the issuance and may result in damages to the corporation. Federal securities
laws are also applicable. I strongly recommend that the corporation seek the
advice of counsel before any issuance of additional stock.
2. Annual Reports. A form entitled "Statement by Domestic Stock
Corporation" must be filed with the California Secretary of State annually. The
form requires the disclosure of the names and addresses of the directors and
principal officers, the address of the corporation's principal office, the name
and address of its agent for service of process, and the number of authorized
directors. I have prepared
and filed the initial annual report.
After the first year, the Secretary of State will mail the form to the
corporation each year, approximately three months prior to the due date (the
month in which the articles of incorporation were filed). If you do not receive
this form prior to the month in which it is due, you should contact the
Secretary of State's office and request that it be sent to you. Failure to
receive the form is not an excuse for late filing. Failure to make a timely
filing of this statement will result in a $250 penalty. In addition, failure to
file this statement for two consecutive years can result in suspension of
corporate rights, powers and privileges. I do not file annual statements
after the first year. That responsibility is yours, but I would appreciate a
copy of your annual filings for my records.
3. Separate Corporate Tax. A corporation is treated as a separate
taxpayer for state and federal tax purposes. As a result, a corporation is
subject to a federal and state income tax on its income. A corporation's
shareholders are generally not subject to tax on corporate income until it is
paid to them in the form of dividends. All corporations must satisfy certain tax
reporting requirements such as the filing of state and federal income tax
returns. The U.S. tax system is the most complex in the world. Tax planning
especially with regard to large transactions or reorganizations of your business
may considerably reduce the corporation's tax. I recommend that you contact me
and your accountant well in advance of any major transactions.
4. S Corporation Election. Certain closely held corporations can elect
S corporation treatment for tax purposes. An S corporation's profits or losses
are generally treated as the profits and losses of its shareholders. As a
result, an electing S corporation is not subject to a tax on its income. In
order to qualify for S treatment in the corporation's first taxable year, the
election must be made within two and a half months after the date of
incorporation and requires the consent of the corporation's shareholders.
5. Election of Tax Year. A new corporation may elect to be taxed using
either a calendar tax year or a fiscal tax year; however, a personal service
corporation and an S corporation usually must use a calendar tax year. The
period chosen must be the same as that used by the corporation to compute its
To adopt a taxable period, a new corporation simply files its initial federal
and state income tax returns on the basis of the taxable period selected. A
subsequent change in the accounting period generally requires advance consent of
the IRS or the California Franchise Tax Board (FTB).
6. Accounting Methods for Tax Purposes.
Generally a corporation must
use the accrual method of accounting for income tax purposes. However, S
corporations and certain qualifying personal service corporations may elect the
cash method of accounting by filing their initial tax returns in accordance with
the cash method of accounting. Once an accounting method has been elected,
approval of a
subsequent change to another method must be obtained from the IRS or the FTB.
7. California Income Tax (Franchise Tax).
A California tax on income,
called a franchise tax, is imposed for the privilege of doing business in
California. A corporation incorporated or qualified to do business in California
is subject to a minimum franchise tax of $800. You are responsible for the
payment of your corporation’s franchise tax.
8. Estimated Franchise Tax Payments.
Installment payments of the
corporation's franchise tax must be paid during the first year. The first
installment generally is due within 3-1/2 months of the commencement of the
fiscal year and is at least the minimum yearly tax of $800. The initial $800
payment made at the time of incorporation does not satisfy this requirement.
Larger payments may be required depending on the corporation's income. You
should consult your accountant regarding
the computation and timing of installment payments.
9. Federal Income and Franchise Tax Returns.
Annual federal income and
California franchise tax returns are due on or before the 15th day of the third
month following the close of the corporation's taxable year.
10. Employer Identification Number. A new business must obtain an
employer identification number from the IRS. Application is made on IRS Form
SS-4. I have instructed you how to obtain the number from the IRS.
11. Federal and California Employment Taxes.
If the corporation has or
will have employees, it will be liable for certain federal and state taxes. As
indicated above, many companies use a payroll service to handle these matters.
These obligations are briefly described as follows:
a. Federal Tax Requirements.
Employers are responsible for withholding
federal income tax from the taxable wages which they pay to their
employees and depositing those funds with the IRS. You will need to
obtain from each employee a properly executed Employee Withholding
Allowance Certificate (IRS Form W-4). Before January 31, following
the close of each calendar year, you must provide each employee with
an Annual Wage and Tax Statement (IRS Form W-2).
Social Security Taxes (FICA). Both the employer and employee
share responsibility for funding the social security system. In
addition to paying its share for each of its employees, an employer
must withhold each employee's share of social security tax from
wages paid to
the employee and transmit those amounts to the IRS.
Federal Unemployment Tax (FUTA). Nearly all employers are
subject to this tax.
Return and Deposit of Taxes.
With some exceptions, employers
subject to either income tax withholding or social security taxes
must file a quarterly return on federal Form 841 and must deposit
the income tax withheld and the FICA taxes with an authorized
commercial bank depository or a Federal Reserve Bank or branch.
b. California Tax Requirements.
In addition to withholding federal income
tax, a California employer is generally obligated to withhold
California state income tax from the taxable wages which it pays to
its employees and deposit those funds with the state.
California Unemployment Insurance Tax.
A California employer
generally must pay unemployment insurance tax if it pays taxable
wages and generally must register with the Employment Development
Department within 15 days after becoming subject to this tax.
California Disability Insurance. California employees (but
not employers) are generally subject to disability insurance tax.
California employers are obligated to collect this tax by
withholding the tax from wages paid to employees. However, the
employer has the alternative of establishing a state-approved
private disability insurance coverage plan. If this option is
chosen, employees may be required to make contributions directly to
this plan in lieu of the tax payment.
c. City Payroll Tax.
An employer who has employees in certain
cities (e.g. San Francisco) may be obligated to pay a city payroll tax.
12. California Sales Tax.
If the corporation sells tangible personal
property at retail in California, it will be subject to the California sales
tax, unless the property sold is specifically exempt. The tax may be passed on
to the purchaser, but the corporation must collect the tax and transmit it to
The corporation selling tangible personal property must file sales tax
returns with respect to taxable sales which it makes and pay or prepay the taxes
collected on a monthly, quarterly or annual basis, depending upon the amounts
involved. If the corporation will be selling tangible personal property, you
should promptly consult the corporation's accountant regarding the dates on
which these returns must be filed and the taxes which the corporation must pay.
13. Seller's Permit.
All parties engaged in the business of selling
tangible personal property in California must obtain a seller's permit from the
California State Board of Equalization. This permit is usually required even
though the business itself sells such property at wholesale (so that sales tax
would not apply). A separate permit must be obtained for each place of business
and conspicuously displayed at
A business having a seller's permit is able to purchase tangible personal
property for resale without having to pay sales tax to the seller, provided it
gives the seller a signed resale certificate in the form prescribed by the State
Board of Equalization certifying that it is purchasing the property for resale.
14. County Real Property Taxes.
The corporation must also pay real
property taxes on items of real property it owns. These taxes are paid to the
county assessor of the county in which the property is located. You should
consult with the corporation's accountant regarding the payment of property
taxes and the necessity of filing property tax statements.
15. Other Taxes. Depending on the nature of your business, there may
be special taxes imposed by federal, state, or local governments, such as those
on alcohol, tobacco, gross receipts, and real estate transactions.
16. Workers' Compensation. California employers are subject to the
state's workers' compensation laws and may be penalized for noncompliance. This
law imposes liability upon employers for industrial accidents, even if the
accident did not result from any negligence of the employer. The purpose of this
law is to provide a fund for payment of expenses incurred in connection with job
related injuries and to compensate the heirs of employees killed in such
The corporation should obtain sufficient workers' compensation liability
insurance from an authorized insurer or obtain a certificate of consent to self
insure from the Department of Industrial Relations.
Workers' compensation insurance is just one of the many types of insurance
which a corporation should carry. We suggest that you consult with a qualified
broker regarding the overall insurance needs of the corporation (see item 20
17. Employee Benefits.
In addition to regular salary or wages, the
corporation may wish to provide other forms of current or deferred compensation
for its employees. Some of these types of compensation, such as bonuses or
payments for sick leave and vacations made out of the general assets of the
corporation, are payroll practices regulated primarily by California laws. Other
forms of current compensation, such as health, disability or life insurance
coverage for employees and their dependents, are welfare benefit plans regulated
primarily by federal laws. Most types of deferred compensation programs, such as
pension or profit plans, are also subject to federal laws. Even for a small
business, complying with federal employee benefit laws may be a complex and
expensive matter. Moreover, failure to comply with these laws may result in
civil or criminal prosecution. In light of the foregoing, we recommend that
you contact me to discuss any programs of current or deferred compensation you
may be considering for some or all of the employees of the corporation. I will
try to refer you to an appropriate person to handle your issue.
18. Notices. Employers are required to post, in a conspicuous
location, a number of notices regarding employees' rights. There is a master
notice covering most of the required notices available from the California
Chamber of Commerce.
19. Labor and Employment Law. There are many federal and state laws
governing the hiring, firing, compensation and other terms and conditions of
employment and, consequently, much overlap exists between these federal and
state labor laws. As with most other regulations, a California employer is
expected to comply with the more stringent standard where regulations overlap.
It is therefore strongly
recommended that you seek legal counsel when you are uncertain as to whether the
state or federal laws apply to a particular employment matter.
Wage and Hour. The California Department of Industrial Relations,
through its Division of Labor Standards Enforcement, enforces state laws
governing payment of wages, the establishment of the minimum wage, hours
of work and overtime and conditions of employment. The federal Fair
Labor Standards Act, enforced through the Wage and Hour Division of the
U.S. Department of Labor, also regulates these areas.
One of the areas in which California law is more stringent than
federal regulations is in the payment of overtime. California law
requires that overtime be paid to non-exempt employees for every hour
worked over eight in a day or over forty in a week, while federal law
only requires payment of overtime for every hour worked over forty in a
week. A California employer must therefore comply with state law in the
payment of overtime.
Discrimination. California's Department of Fair Employment and
Housing prohibits unlawful practices in the hiring, employing and
discharging of all persons to protect them against discrimination with
respect to race, religious creed, disability, color, sexual orientation,
familial status, marital status, national origin, ancestry, sex, age,
and medical condition. Title VII of the Federal Civil Rights Act of
1964, the Federal Age Discrimination Employment Act of 1967, the Equal
Pay Act of 1963 and the Americans with Disabilities Act also regulate
fair practices in employment.
Health and Safety.
The health and safety of California workers is
generally regulated by the Division of Occupational Safety and Health of
the California Department of Industrial Relations and the Occupational
Safety and Health Administration of the U.S. Department of Labor. Both
these agencies have established health and safety standards to be
followed by all employers, and require the correction of all conditions
created by an employer which threaten the health and safety of its
The National Labor Relations Act (NLRA)
protects employees' rights to organize and to bargain collectively with
their employers through representatives of their choosing. These rights
include forming or joining a union; assisting a union to organize
employees; striking to secure better working conditions; and, with or
without the presence of a union, engaging in concerted activity related
to wages, hours and working conditions. Specific rules apply to an
employer's rights and obligations in this area, and it is therefore
recommended that an employer seek legal counsel for advice in the event
of any union or other concerted activity by employees.
During the 1980's, the doctrine of "at-will"
employment has been severely eroded by California case law, impairing
the ability of employers to discharge employees "at-will." As a result,
wrongful discharge lawsuits are very common. Written or verbal
statements made to employees, personnel policy manuals and company rules
may be interpreted as creating a contract between the employer and
employee precluding the employer from firing an employee except for
"just cause." Employers in California should therefore be aware of the
legal ramifications of statements made to employees about terms and
conditions of employment and should, in most cases, obtain legal advice
in regard to potential employee terminations.
20. Insurance. The corporation should consult a qualified insurance
broker to determine which types of insurance policies should be purchased. It is
generally advisable to obtain fire and extended peril insurance on all property
which the corporation owns. A comprehensive public liability insurance policy is
also advisable (and may from time to time be required for various purposes).
Product liability insurance is also advisable for many businesses, as are other
specialized types of insurance which may be applicable to your business.
21. State and Local Business Licenses.
State and local licensing is
required for a wide variety of business and professions that may be conducted in
the corporate form. Some cities in California require certain businesses to
obtain a license and pay a tax for the privilege of doing business in that city.
Local business tax authorities will provide information on business license
22. Local Taxes. A few cities, including Los Angeles and San
Francisco, impose a tax on the gross receipts of various businesses. Detailed
information is available from local tax authorities.
Fictitious Business Name. Trade Names. Trademarks and Trade Secrets.
As you do business as a corporation, you will be using your corporate name as
your trade name. You may also adopt an abbreviation of your corporate name, much
as Pan American World Airways, Inc. does business as PAN AM or may adopt an
entirely different name as your trade name.
Should you adopt a trade name different from your corporate name, you should
inform me so that I may assist you in preparing, filing and publishing a
fictitious business name statement where this would be advisable.
Trade names (or corporate names) also frequently function as trademarks or
service marks. "PAN AM", for example, is a service mark for airline passenger
services. Besides being International Business Machines, Inc.'s trade name,
"IBM" also functions as a trademark which distinguishes IBM's products from
Trademark and service mark rights belong to the first person to use a mark.
Therefore, it is advisable to determine the availability of a particular mark or
trade name before you spend money establishing it. To prevent interference in
the future from another with superior rights to a mark or name, I recommend that
you consult me before adopting a trade name or trademark.
Note that merely having a name registered as a California corporation will
not give you federal trademark rights to it; it merely means that there is no
other California corporation with the same name.
If a creative process is involved in the production of the corporation's
products, a patent and suitable contractual arrangements may be appropriate to
protect and preserve company ownership. Trade secrets may be protected by plant
security and by requiring employees to sign agreements guaranteeing the
safekeeping of trade secrets and confidential information. Intellectual or
literary property may qualify for copyright protection.
24. Securities. The issuance of securities by the corporation is
subject to both federal and state securities laws. Although the federal and
state definitions of a security are not identical, such definitions are quite
broad and include stocks, options, warrants, evidences of indebtedness,
investment contracts, and interests in a stock or profit-sharing plan. Officers
and directors may be held personally liable for criminal and civil violation of
securities laws. Thus, whenever a corporation considers offering, issuing, or
selling securities, it must be cognizant of applicable federal and state laws.
The corporation also should be aware of "private placement" and "limited
offering" exemptions from these plans.
Because of the complexity and high risks involved, I recommend that you
contact me to assist the corporation with any securities-related transaction –
for example, additional investments in the corporation by existing or new
investors – before any phase of the transaction is undertaken.
25. Doing Business in States Other Than California.
26. Termination and Dissolution
corporation nor its employee-benefit plans (if subsequently established) should
be terminated or dissolved without consultation with an accountant and with
counsel. A corporation is not dissolved by reason of the death or
disqualification of the sole
remaining shareholder-director. Dissolution is accomplished only as provided by
the California Corporations Code. In a similar vein, no pension or
profit-sharing plan or other compensation arrangement you may establish should
be terminated or altered without careful review and study by the advisers of the
me to schedule a legal consultation: