Business Structures 101: Corporations

Posted by Mike Mangini, Wednesday, February 17, 2010

What sets the corporation apart from all other types of businesses is that a corporation is an independent legal entity, separate from the people who own, control, and manage it. In other words, corporation and tax laws view the corporation as a legal "person" that can enter into contracts, incur debts, and pay taxes apart from its owners. Other important characteristics also result from the corporation's separate existence: A corporation does not dissolve when its owners change or die, and the owners of a corporation have limited liability -- that is, they are not personally responsible for the corporation's debts.

If a business owner has "limited liability," it means that he or she is not personally responsible for business debts and obligations of the corporation. In other words, if the corporation is sued, only the assets of the business are at risk, not the owners' personal assets, such as their houses or cars. The corporation's owners must comply with certain corporate formalities, keep up with paperwork requirements, and adequately fund their business to maintain this limited liability privilege.

Limited liability, traditionally associated with corporations, is the main reason most people consider incorporating. However, a relatively new business structure, called a limited liability company (LLC), now offers this limited personal liability to business owners, too. Sole proprietorships and partnerships do not.

Corporations can also differ from other business structures in the way they are taxed. The traditional "C" corporation itself must pay corporate income taxes on its profits -- whatever is left over after paying salaries, bonuses, and other deductible expenses. This is often referred to as "double taxation," but, despite the moniker, corporate taxation can be advantageous depending on the business. In contrast, partnerships, sole proprietorships, LLCs, and Subchapter-S Corporations (sometimes referred to closely held corporations) are not taxed on business profits; instead, the profits "pass through" the business to the owners, who report business income or losses on their personal tax returns.

There are some expenses and formalities involved in setting up a corporation and issuing stock, which are not present in other types of business organizations, such as LLCs, but it has several advantages that may make it worth the extra trouble. If you are a very small business and merely want to limit your personal liability for business debts, forming a limited liability company (LLC) should also be considered, because LLCs are oftentimes easier to run.

There are several steps required to legally create a corporation. The first is filing a short document called "articles of incorporation" with the corporations division of your state government. (Some states refer to this organizational document as a "certificate of incorporation," a "certificate of formation," or a "charter.") You'll have to pay a filing fee that ranges from about $100 to $800, depending on the rules of the state where you file.

Additionally, corporations must comply with statutory rules that unincorporated businesses, such as limited liability companies (LLCs), partnerships, and sole proprietorships, do not. For instance, corporations must observe corporate formalities such as holding and taking minutes of annual shareholder and director meetings and documenting important decisions.

In sum, there are a number of good reasons to incorporate your business. Whether incorporation is right for your business depends largely on how much you’ll benefit from these advantages, such that it is worth complying with the extra duties created by choosing this business structure.