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Incorporation of a Business - The Basics

Needless to say, incorporation of a business is major decision, and a legal one. So while we attempt to uncover some of the basic principles behind business incorporation, you would be wise to find out the legal implications specific to your business and state (or country if you're outside of the USA).

It's not as simple as filing some papers and away you go - there are naturally important things to know and consider before you incorporate small businesses.

The Main Advantage of Incorporation of a Business is...

Limited Liability. You've probably heard that by incorporating your business you limit your personal liability for any debts your business owes. While this is true to a large extent, your business needs to meet certain conditions as a corporation to retain its limited liability privileges.

So, let's say your corporation owes $500,000 to creditors, as long as you fulfill the requirements of incorporation, those creditors would not be able to claim against any personal assets such as your house, for example.

So What are the Requirements?

Running a corporation involves much more than setting one up. Corporations are required to maintain detailed records and accounts in order to process the complexities of corporate tax returns. Aside from proper record-keeping, corporations are required to arrive at business decisions in a certain way that makes them quite different to sole proprietorships and partnerships.

Some of the main formalities underlying incorporation of a business include:

Investing an appropriate amount of funds into the corporation (otherwise known as capitalizing the company)
Formally issuing stock to the primary shareholders of the company
Holding regular meetings of shareholders and directors
Arriving at business decisions through a quorum of directors or shareholders (unlike sole proprietorships in which business owners can make decisions on their own)
Keeping meticulous records and transactions, and keeping them separate from the personal activities and records of the owners

Incorporation Doesn't Always Limit Liability

There are some instances in which incorporation of a business doesn't limit the liability of its owners. Owners of a corporation can still be held personally liable under the following circumstances:

Mixing the personal affairs of the owner with that of the corporation, rather than keeping them separate
Failing to remit taxes withheld from employees' wages and salaries
Intentionally engaging in fraudulent or illegal activities as a corporation
Defaulting on a bank loan in which a personal guarantee was given by the owner in order for the corporation to receive the loan
Negligence, or causing personal injury to someone

Being paid as an owner of a corporation

Whereas sole proprietors and partners may draw equity from the company, owners of corporations are usually employees and receive a salary of the company. Therefore, the owner pays personal income taxes just like any employee and thus must file a personal income tax return and report the income earned as salary.

The corporation on the other hand must file a corporate tax return, and is required to pay taxes on net profits (net income after all expenses have been paid). Corporate tax rates differ from personal tax rates.

Steps to Incorporation of a Business

The actual formality of incorporating a business is not very complicated. Small corporations are relatively easy to file, and there are several services both online and offline that help incorporate small businesses.

You need to file the articles of incorporation in your state. Articles of incorporation for small corporations usually require basic information such as the company name and address, the contact information of someone involved in the corporation, and in many instances, depending on the state or country in which you will incorporate, a list of directors or shareholders of the corporation.

Get Legal Advice

As mentioned earlier, it goes without saying that you should consult legal and tax professionals regarding incorporation of a business before you embark on filing for incorporation. If you're going to incorporate, know all of the implications and responsibilities of doing so.

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