Pros and Cons: Why Form a Corporation?

Wed Apr 1, 2009 10:02am EDT

Deciding whether or not to incorporate is an important choice to make when starting your new business. Following is a discussion of the main pros and cons of forming a corporation.

PROS

Owner Protection from Legal Liability. Once a new business's owner(s) successfully completes the incorporation process, the owner(s) have a limited amount of legal liability for the corporation's business activities and debts, because in the eyes of the law the corporation is a separate entity. In order to maintain this limited liability, the corporation's owners must follow a number of legally required corporate formalities.

Ability to Attract Investors. The corporation's ability to issue stock is a strong selling point to those willing to invest capital in a business venture.

Power Structure. The corporate business form has an established power and management structure: directors, officers, and shareholders. Each group has its own set of clearly-defined roles and responsibilities within the corporate framework.

Stock and Stock Options for Employees. Especially for larger businesses, the corporate business structure offers an appealing opportunity to potential employees -- stock benefits and stock options (the employee's right to buy stock at a locked-in price).

CONS

Time and Cost of Incorporation. The incorporation process can be expensive and time-consuming. A number of documents must be prepared (including the new corporation's articles of incorporation and bylaws), and filing fees must be paid to your state's Secretary of State office (or similar business filing agency).

Following Corporate "Formalities." All corporations are required by law to observe a number of corporate formalities, to ensure that the corporation is operating as a separate entity, independent of the business's owners. These steps include holding regular meetings of directors, keeping records of corporate activity, and maintaining the corporation's ongoing financial independence.

Potential Tax Liability. The profits from traditional corporations may be "double taxed." That is, the corporation itself is taxed for any profits earned, and any individual stockholder who earned profits from the corporation (in the form of paid "dividends") are also taxed. This occurs most often in larger corporations, and may not be an issue for stockholders and owners of smaller corporations, who often work for the business itself and are paid salaries (which are tax-deductible for the corporation) rather than dividends. One solution to the double-taxation problem is electing "S" corporation tax status.

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