The pandemic triggered a boom in the formation of new businesses across the country. Entrepreneurs in the United States, and indeed, the rest of the world, were responding to the tectonic shift in the way we work and live, and the massive opportunities that this presented. For many of these entrepreneurs, an important part of their entrepreneurial journey has involved answering a simple question: “Should I incorporate my business?”
A Corporation Has Personhood
United States law holds that a corporation has personhood. This means that it has certain rights and responsibilities that natural persons have. They can, then, enter into contracts with third parties, sue and be sued, and engage in other activities separate from its shareholders.
Corporations are unique in this regard. This affords shareholders as well as many enormous advantages which will become clear as we go along.
A Corporation Is Liable for Taxes
As a distinct person, a corporation is therefore a taxpayer like you and I. This is an advantage because corporate tax rates are often lower than those of individuals, and corporations have tools that allow them to legally reduce their tax bill. For instance, a corporation may shift its domicile to a tax friendly environment, or, using various structures to defer paying taxes. Corporations generally make the same deductions to derive their taxable income as sole proprietors, but they also enjoy special deductions. These are advantages that are impossible for a sole proprietor to replicate and extremely difficult for other business structures to match.
However, corporate profits are subject to double tax: the corporation is taxed when it earns the profit, and the shareholders are taxed when they receive dividends. There are no tax deductions for distributing dividends. However, companies may and many often do, retain all or a significant proportion of earnings, choosing instead to reinvest them, or simply build up a war chest.
As a shareholder of your business, you must have a clear idea of what will happen to earnings. Are you happy to distribute dividends, or will you retain all or a significant chunk of them? Remember, because a corporation is its own person, its income is separate from yours. You have to appreciate this segregation. People who have operated as sole proprietors grow accustomed to thinking of themselves and their business as the same thing. With a corporation, that isn’t the case.
A downside, but not a significant one given the benefits, is that being a corporation comes with more paperwork and the fees that have to be paid to process that paperwork.
A Corporation Existence is Perpetual
A key difference between shareholders and a corporation’s personhood is that corporations have, theoretically at least, an infinite lifespan. The Japanese construction company, Kongō Gumi, operated for 1,426 years before liquidating. Corporations can go on and on and on because their existence is separate from that of their shareholders.
Corporations are useful for estate planners, especially when a family owns a business. By separating shareholders from the corporation, a family can save on Property Transfer Tax while still passing on the family’s real estate.
In order to ensure that your business’ life continues, you have to keep it in good standing with the state it is registered in and with the Internal Revenue Service (IRS). This means filing your annual reports, paying your taxes, and complying with other regulations. If you do not keep up with your filings, then your company may be forcibly dissolved. The other obvious thing of course is that your business should remain profitable.
Liability Protection
Liability protection is a powerful reason for incorporating and is reinforced by the personhood of the corporation. Again, you and the corporation are two distinct persons, therefore, your corporation’s creditors cannot come after you for any liabilities the corporation has.
The company’s shareholders enjoy this protection because the framers of corporate law felt that it gave them an incentive to take risks and start businesses. If people always feared that their and their family’s assets would be subject to lawsuit if their company failed, they would be less willing to take risks and become entrepreneurs.
You should take advantage of the liability protection afforded by corporations as a way of shielding your private assets from your company’s potential creditors.
However, the “corporate veil” separating company’s and its shareholders can be pierced. If, for instance, you keep company funds in a bank account under your name, then the company’s creditors can argue that you and your company are in effect, one person, and that, therefore, your assets can be the subject of a lawsuit.
Furthermore, for small businesses and even in some case, large businesses, the company’s shareholders may be asked to provide personal guarantees for loans. This happens if lenders are not comfortable with the assets owned by a corporation, either because their liquidity is questionable, or their quality is insufficient. Or, a business may simply not have enough collateral for a loan, as often happens with startups.
In some instances, company directors may be liable for the actions of the company’s they serve, if, due to their actions or lack thereof, that company violates some law.
Greater Fundraising Ability
Operating as a corporation affords a business a special status. A corporation can issue shares in exchange for capital from its shareholders. This makes it a very attractive vehicle, if you plan on raising capital among private investors or on public markets.
The ability of corporations to raise capital in this way makes them the most popular business structure for growing, capital hungry firms.
Conclusion
Given the complexity of the subject, you are advised to seek counsel before deciding on whether or not you want your business to file articles of incorporation. You can get more information about incorporation here.
In addition, you have to think about the goals that you have for your business. As we have seen, corporate personhood gives corporations significant advantages over other business structures.
Corporations have enormous ability to scale, and raise capital, and they enjoy features that are incredibly attractive for all entrepreneurs.