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What is a corporation?

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," meaning that the corporation can enter into contracts, incur debts, and pay taxes apart from its owners. And there are other important characteristics that result from the corporation's separate existence: A corporation does not dissolve when its owners (shareholders) change or die, and the owners of a corporation are not personally responsible for the corporation's debts; this is called limited liability.

Who should form a corporation?

Because of the expense and formalities involved in setting up a corporation and issuing stock (shares in the corporation), you should form a corporation only if you have good reason to do so. If you merely want to limit your personal liability for business debts, forming a limited liability company (LLC) is probably smarter, because LLCs are both less expensive to form and less complex to run. But here are some situations in which incorporating your business instead of forming an LLC may make sense:

Your business needs the ability to issue stock or stock options to attract key employees or outside investment capital.
Your business is so profitable that you can save significant income tax dollars by keeping some profits in the corporation each year. This strategy is called "income splitting" because profits are essentially split between the individual owners and the corporation itself.
You own a family business and you want to begin making gifts of ownership to your family as part of your financial or estate plan or to plan for the next generation of owners. With a corporation you can easily make gifts of shares in your company without necessarily giving up management control and, if it's done correctly, without paying gift tax.
Others insist that you incorporate your business. For example, if you are an independent contractor, companies you want to work for may ask you to incorporate before they will sign contracts for your services. This is because if you form a corporation, the IRS is more likely to view you as an independent contractor than an employee -- a less-risky proposition for those who want to hire you.

Does running a corporation involve more paperwork than running other types of businesses?

Yes. 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 directors' decisions. Also, corporations must file and pay taxes on a separate corporate tax return and must set up a double-entry bookkeeping system to record business transactions, complete with daily journals and a general ledger.

DISCLAIMER: This site and any information contained herein are intended for informational purposes only and should not be construed as legal advice. Seek competent legal counsel for advice on any legal matter.

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