Advantages and Disadvantages of Forming a Corporation

A corporation is defined as a legal entity or structure created under the authority of a state's laws, consisting of a person or group of persons who become shareholders. The entity's existence is considered separate and distinct from that of its members. Like a real person, a corporation can enter into contracts, sue and be sued, pay taxes separately from its owners, and do the other things necessary to conduct business.

Incorporation can be a complicated process. You may choose to hire an attorney to guide you through the process (read Do I Need an Attorney to Form a Corporation? for more information).

Regardless of the tack you take, take into consideration the advantages and disadvantages listed below before you embark on incorporating your company. And when you're ready to incorporate, make sure to read Once You've Decided to Incorporate.

Advantages

• Limited liability. One of the key reasons for forming a corporation is the limited liability protection provided to its owners. Because a corporation is considered a separate legal entity, the shareholders have limited liability for the corporation's debts. The personal assets of shareholders are not at risk for satisfying corporate debts or liabilities.
• Corporate tax treatment. Since a corporation is a separate legal entity, it pays taxes separate and apart from its owners (at least in the typical C corporation). Owners of a corporation only pay taxes on corporate profits paid to them in the form of salaries, bonuses, and dividends. The corporation pays taxes, at the corporate rate, on any profits.
• Attractive investment. The built-in stock structure of a corporation makes it attractive to investors.
• Capital incentive. The stock structure also allows corporations to attract key and talented employees by offering them an ownership interest in the form of stock options or stock.
• Owner/employee. A business owner who works in his or her own business may become an employee and thus be eligible for reimbursement or deduction of many types of expenses, including health and life insurance.
• Operational structure. Corporations have a set management structure. The owners of a corporation are shareholders, who elect a Board of Directors, which then elects the officers. Other than the election of directors, shareholders do not participate in the operations of the corporation. The Board of Directors is responsible for managing and exercising the rights and responsibilities of the corporation. The Board sets corporate policy and the strategy for the corporation, and elects officers — usually a CEO, vice president, treasurer, and secretary — to follow the policies set by the Board, and manage the corporation on a day-to-day basis. In a small corporation, the lines between the shareholders, Board of Directors, and officers tends to blur because the same people may be serving in all capacities.
• Perpetual existence. A corporation continues to exist until the shareholders decide to dissolve it or merge with another business.
• Freely transferable shares. Shares of corporations are freely transferable, because as a separate entity, the existence of a corporation is not dependent upon who the owners or investors are at any one time. A corporation continues to exist as a separate entity, and is not terminated or dissolved even when shareholders die or sell their shares. Shares of corporations are freely transferable unless shareholders have "buy-sell" agreements limiting when and to whom shares may be sold or transferred. Also, securities laws may restrict the transferability of shares.