Incorporation, the act of forming a corporation, is right for some businesses but not all. A corporation is a business entity that is separate from its owners. It acts as a legal "person" that carries on business through officers and directors for its shareholders, who are not personally responsible for its acts. It is formed under state business law by filling Articles of Incorporation. Incorporation is generally a complicated process and it is often necessary to hire an attorney. Choosing to incorporate a business has its pros and cons. To determine if you should incorporate, read through the following advantages and disadvantages.
The Advantages of Incorporation
- Limited Liability Protection: Owners of a corporation have limited liability protection. This means that the shareholders have limited liability for any corporate debt or lawsuits due to the fact that a corporation is a separate legal entity. Additionally, officers do not have any personal liability for corporate acts.
- Corporate Taxation: Owners of a corporation must only pay taxes on salaries, bonuses and dividends and not any corporate taxes. The corporation, as a separate legal entity, will be required to pay its own taxes.
- Ability to Obtain Funds: If you establish a corporation when the business is small, you can grow by going public and finding angel investors and venture capital. Limited liability companies also attract these investors, but many of them prefer a corporate structure, which offers more legal liability protection. Additionally, the stock structure of the corporation attracts investors as well talented employees by offering stock and ownership interest in the form of stock options.
- Corporate Structure: The corporate structure is rather formal and includes a Board of Directors that helps oversee the operations of the business. The owners of the corporation will elect the Board members but will not take part in any of the operations. The Board will also elect officers including the CEO, vice president, treasurer and secretary. The Board will also establish corporate policies and strategies. The shareholders, directors, and employees have defined roles and responsibilities. The larger the corporation, the more defined these roles are. Smaller corporations may have officers and shareholders who play multiple roles.
- Continuous Existence: Even if a corporation loses its shareholders or has shareholders who sell all their shares, the corporation will continue to exist. These shares are transferable unless the shareholders have specific agreements that limit the selling or transferring of shares.
Disadvantages of Incorporation
- Cost: The primary disadvantage of a corporation is the cost. Different fees must be paid such as the fee to file the Articles of Incorporation, first-year franchise tax prepayment, governmental filings and attorneys' fees. Although some people try to form corporations on their own to save money, it is wiser to hire an attorney. Thus, the cost of incorporation can reach several thousands of dollars, depending on the complexity of the business. Hiring an attorney is worth the money considering that any deviation from the correct incorporation process could mean the loss of the corporate protection.
- Formalities of Corporate Structure: Corporations must follow the formalities of the corporate structure, when it comes to record keeping, meetings, and notification procedures. This ensures that the corporation will receive all benefits of incorporating.
- Double Taxation: When it comes to taxes, the shareholders or owners of C corporations are subject to "double taxation." The owners are not only taxed on the profits of the entity, but also on dividends they receive as shareholders. The additional taxation of earnings for owners is due to the fact that many of them are also employees at the same time.
- Heavy Paperwork: Due to corporate formalities, all sorts of paperwork must be documented and filed including reports and tax returns. Records of corporate actions such as meetings of shareholders and Board of Directors must be kept and business bank accounts must be maintained.