Rewards and Drawbacks of Forming a Corporation

There are many questions to consider before turning your business into a corporation. Seemingly simple tasks, such as choosing the correct type of corporation for your company, require extensive contemplation. Before diving into a difficult process, take the time to look over some pros and cons of incorporation, as well as how commercial liability and business insurance can put you at ease while forming a corporation.

Choose the Right Type of Corporation

A common misconception is that only certain types of businesses can incorporate. This is simply not true. Any business, from the smallest to the largest, can reap the benefits of becoming a corporation. However, deciding which type of corporation best suits your business requires careful measurement. There are many types of corporations, and one may have benefits that are better suited to your business.

A general corporation is the most common type. Owned by stockholders, this type of corporation is legally a separate entity, and stockholders are limited in liability to only the investment they've put into the corporation. Some benefits include tax exemption for particulars, protection of owners' personal property, and a general increase in capital due to the sale of bonds and stocks. Disadvantages include more legal paperwork that must be done vigilantly and on time, as well as an increase in regulations and rules by the state.

The S corporation or "S corp" is designed for tax advantages, and has become very popular among small-business owners and certain sole proprietors. S Corporations differ from general and close corporations in that they pay taxes on profit that the business makes, as well as personal taxes on dividends profited, and any salaries paid out. S corporations evade double taxation by allowing only one tax report to be filed from personal shareholders of the business. Although this evasion of double taxation is very beneficial, restrictions must be examined carefully. Filing to become an S Corporation can be a difficult task. Certain regulations must be met and abided by to qualify to become an S Corporation. It is best to obtain assistance from an attorney for more complicated matters.

A close corporation is similar to a general corporation, but is limited to the number of stockholders in the corporation. Often, the number of stockholders is no more than 50. The close corporation is also required to offer shares of the company first to current stockholders before selling to new ones, meaning that stockholders do not change significantly for long periods of time. This is perfect for a group of associates who only want to be involved at the minimal level, while others are highly involved in the everyday decision-making processes.

An L.L.C., or limited liability company, is one other form of corporation. This form combines the benefits of a partnership with a corporation. The tax benefits of the S corporation come into play, while maintaining the liability security that a partnership offers its owners: protection of personal property from any debt. Therefore, the L.L.C. has become very popular among small businesses and sole proprietors.

Benefits of Becoming a Corporation

Though each type of corporation has its own advantages, all corporations offer the same main benefits.

One of the biggest advantages of incorporating is limited liability. Because legally a corporation is a separate entity, all business owners and shareholders are limited in responsibility for any debts that the company holds. Thus, the shareholders’ personal property cannot be seized to settle debt with creditors of the business.

A corporation’s structure can also be a big advantage. The corporation’s officers, such as the vice president, treasurer and chief executive officer, are put in position by the board of directors, who are in turn elected by the shareholders or owners of the company. Therefore, a set structure determines who does what and when, resulting in the quick resolution of any problems.

Tax benefits are also a major reason for a business to incorporate. Depending on the type of corporation, as a separate legal entity, the corporation will pay taxes independently from the shareholders, and shareholders will only be taxed on any income given to them in dividends, salaries or bonuses. However, if you form an S corporation or L.L.C., you are then able to avoid “double taxation.” This means that only one report on earnings will be filed on your personal tax report, and profits will only be taxed once.

Corporate health care plans can be developed, offering beneficial retirement options that non-incorporated companies could not provide. This, along with stock options and other benefits, make the company more attractive to potential employees, which brings in more experienced personnel.

Higher profits are another advantage to incorporating, as capital from investors allows for a bigger and broader reach. Therefore, expanding the corporation into different endeavors is a good possibility.

The idea of perpetual existence can also be attractive to those looking to incorporate. This is the concept that the corporation will maintain its existence until all shareholders decide to liquefy assets or create a merger with another company. Therefore, if one owner sells out or passes away, the company will continue.

Drawbacks to Incorporating

Though the benefits of incorporating are numerous, a variety of drawbacks must also be weighed. The first big drawback is the cost of incorporation. Fees can be high, and include:

  • Tax prepayment for first-year franchises
  • Government filing costs
  • Filing your articles of incorporation through the Secretary of State
  • Hiring of an attorney, which might be beneficial for the initial startup of your corporation

With a C corporation, there is also the disadvantage of double taxation. The corporation is taxed for profits made, and you are personally taxed for profits paid to you by the corporation. However, as explained above, this is avoided with an S corporation or L.L.C.

Another disadvantage to a corporation is the extensive reports and paperwork that must be done constantly. Records of every move must be vigilantly kept, and such things as tax returns filed efficiently and on time. Paperwork can become costly, as people must be hired to keep track of records, organize and file on time.

The rules and regulations that come with forming a corporation must be abided by as well, or the benefits will be revoked. Policy regarding corporations is extensive and must be paid respect. Therefore, it can be a drawback if guidelines are not followed strictly.

How Commercial Liability Insurance Helps

Although there are many liability benefits when forming a corporation, it is still recommended that the owners obtain some sort of commercial liability insurance or business insurance. Though the personal property of the shareholders in a corporation is less liable for any accidents, the company is still responsible. Therefore, it is important to assess the types of risk that your corporation could be subject to, and purchase the proper insurance accordingly. Having the right insurance for your company will ease any difficulties in forming the corporation by ensuring that you are protected against such claims as bodily injury or property damage.

Some types of commercial liability insurance or business insurance to consider are:

  • A business owner policy, or BOP: This general commercial liability insurance package will cover general liability for any claims of injury, as well as property damage and business interruption, which protects the profits you would have made while recovering from disaster.
  • Professional liability insurance: This type of business insurance protects you from expensive litigation that could result from negligence or inadequacy.
  • Automatic additional insured: This is coverage that is automatically provided when it's obligatory by contract.
  • Employment practices liability insurance: This insurance protects you from any claims an employee might have about improper treatment at the workplace.
  • Umbrella insurance: Umbrella insurance is a type of commercial liability insurance that covers you when your other liability insurance has reached its given limit.
  • Product liability insurance: When a product you've made causes harm to someone or their property, this type of insurance will cover them. This type of coverage is especially important for businesses in food or toys, which regularly have such problems.
  • Commercial automobile insurance: As a corporation, it is possible that you will have a vehicle or vehicles that are used for business. Commercial auto insurance will provide insurance for you and your employees when using the business vehicle(s).

If you own a corporation – or any type of business – insurance is a necessity. One small lawsuit could set business back for years. Therefore, commercial liability insurance and general business insurance should be taken into consideration when running any company. Not only will it ease your mind when starting up a corporation, it will allow your business to grow even more.

Incorporate or Not

When deciding to incorporate, the considerations can be mind-numbing. If you decide to make your business into a corporation, build a business insurance plan that will help you through the process. Ensure that your corporation and personal assets will be safe from creditors by consulting with a professional commercial liability insurance firm. The firm’s expertise will help you through one of the biggest moments for your small business.

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