When creating a new business, the owner can structure the business in a number of ways that best suit his preferences as well as the type of business he is creating. When a business becomes incorporated, it has completed the process of becoming a corporation, as recognized by state law. Incorporation provides the owners with many advantages, but the primary benefit is the business will be viewed as a separate entity from its owners.
What is a Corporation?
A corporation is a type of business organization viewed as a separate legal entity under state law. This allows the corporation to do things a person can do, such as pay taxes, initiate litigation and be sued by others. Parties who sue the corporation are limited to the corporation’s assets and are unable to tap into the shareholders’ personal assets. Shareholders' liability is limited to their investment in the corporation, thereby protecting their personal assets.
How to Form a Corporation
Corporations are creatures of state law; therefore, the particular state where you incorporate will determine how you must establish the corporation. Generally, the founders of the corporation draft articles of incorporation that must be filed with a state agency like the Secretary of State. Many states require corporations to adopt a business name that indicates its designation as a corporation. This designation is often expressed through the use of “Inc.” in the business name. This essentially puts its customers and other individuals on notice that the business is a corporation. In addition to filing the articles of incorporation, the company must continue to meet the state’s continuing disclosure rules, like annual reports and fee requirements.
Benefits of Corporate Form
Corporations, unlike partnerships, have an unlimited life, meaning the corporate form will continue indefinitely unless the shareholders or board of directors take active steps to end the corporation. This is significant because default state laws for partnerships typically dissolve a partnership when partners leave. In addition to unlimited life, the corporate form offers protection from personal liability for the shareholders of the corporation. Shareholders are liable for the actions and debts of the company only to the extent of their investment. Shareholders, however, may be held personally liable for willful wrongdoing. The final benefit is that corporations are taxed at a lower rate than individuals, so corporate earnings can grow in a more tax efficient manner than if the business entity was a partnership or sole proprietorship where taxes are passed down to owners who include them on their personal income tax returns.
Disadvantages of Corporate Form
Many people consider the corporate form to be disadvantageous because of the double taxation issue. Double taxation occurs because a corporation must pay taxes on the profits it earns and those profits are typically shared with the corporation’s stockholders through dividends. Shareholders must then include these dividends as part of their personal income for the year and are taxed on it again.