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Is Incorporating Right for You?

Mar 1, 2008
Deciding what kind of business entity makes the most sense for you depends on the type of business, various tax and liability issues, and the wishes and plans of the owners. The main choices to consider are the sole proprietorship, a general or limited partnership, a limited liability company (LLC), or a corporation (inc.).

A corporation is a legal entity formed and regulated under state and federal corporate laws. Each corporation must have a board of directors, shareholders who own stock in the corporation, and officers of the corporation who run the day-to-day affairs of the business.

Corporations make a lot sense for companies which are poised to grow and attract investors. Also, because a corporation has strict paperwork requirements, the business is usually easier to sell than other types of businesses because it's easier for an outside buyer to determine exactly what is occurring within the business. If you have visions of becoming a publicly-traded company, a corporation structure is required.

Characteristics of the corporate structure include:

Perpetual Existence: Corporations are designed to last forever. They are not dependent on the death of a single owner, but can be sold or dissolved by voluntary action of the board of directors.

Control and Management: A corporation is managed by a board of directors, who are elected by the shareholders. The board of directors, in turn, select the officers who handle the day-to-day business under the guidance of the board of directors. Though there is no statutory minimum for the number of directors, it is almost impossible to run a business with less than three (3) directors because most decisions need to be made by a majority.

Shareholder Rights: Shareholders have rights in a corporation, including the right to vote for the board of directors, the right to share in profit distributions, and the right to access financial and business records of the corporation.

Stock: Shareholders receive stock in the corporation in exchange for their investment in the company. Depending on the bylaws of the corporation, there may be various types of stock available, typically common stock and preferred stock. Issuing stock requires approval of the board of directors and must follow many federal and state securities laws.

Corporate Formalities: Corporations must be observed to maintain the liability limitations that protect the individuals who own the corporation. These formalities include maintenance of separate corporate finances, official corporate meetings and minutes from those meetings and periodic governmental filings. Though these formalities may be time-consuming at first, they are required to keep a corporation's liability protection intact for its investors.

Limited Liability: One of the key advantages of a corporation is the liability protection it provides its board of directors and officers. However, that liability protection can be breached if the corporation is not run properly. Lawsuits that successfully reach the individuals behind a corporation are called "piercing the corporate veil."

Taxes: There are two types of corporations when it comes to taxation: a C-Corporation and an S-Corporation. A C-Corporation is the traditional corporation and is subject to double taxation: the corporation pays corporate tax on its profits, and then the individual shareholders pay personal income tax on any dividends that are distributed to them from those same profits. An S-Corporation, on the other hand, does not pay corporate tax, but instead passes all business income through to the individual shareholders to be reported as individual income and taxed accordingly.

While an S-Corporation can often be advantageous, there are certain rules that must be followed in order to qualify. 1) The election to become an S-Corporation must be filed with the IRS within the first 75 days of operation of the company. This is accomplished by filing IRS Form 2553. An S-Corporation can have a maximum of 75 shareholders and can have only one type of stock. Also, shares of an S-Corporation cannot be held in a trust or be owned by individuals in another state. Also, shares cannot be owned by another corporation. In other words, it cannot be a subsidiary corporation.

Setting up a corporation is not complicated. There are standard forms to be filed with the Secretary of State, along with your Articles of Incorporation. Bylaws of the corporation must be written and approved by the board of directors, stock certificates created, and the various corporate formalities established.

Before creating any type of business entity, it's a good idea to discuss the advantages and disadvantages of each type of business with an attorney, an accountant, or other trusted business advisor. No one solution is right for every situation, so get the facts before you decide.
About the Author
Katryna Johnson is an attorney and small business consultant running several websites with resources for small business owners. Setting up a corporation is only one option to explore. For more information, visit http://www.BizLawResource.com
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