Pros and Cons of Incorporating a Small Business

Deciding Whether to Form a Business Corporation

Apr 30, 2009

An important consideration in starting a small business is choosing the right type of business organization. The corporate form has advantages and disadvantages.

One of the most common business organizations in the United States is the corporation, a legal entity formed under state law. A corporation can be a general business corporation (commonly called a "C-corp"), a close corporation, a professional corporation or a nonprofit corporation. Small business owners who decide to incorporate often pick the close corporation. In a close corporation, the shares are restricted to a certain number and are not publicly traded.

A big advantage of the corporate form involves its identity as a separate legal entity. It can sue, be sued, own property and enter into contracts in its own name. As a general rule, investors in a corporation can be owners of the company without assuming liability beyond the cost of their individual shares. Unlike a sole proprietor, the owner of a corporation does not risk all of his or her personal assets in the business.

Continued Existence- A Corporation Does Not Die With Its Owners or Officers

Whereas a sole proprietorship or a partnership will terminate or dissolve upon the death or incapacity of its owners, a corporation will continue to exist until it is either voluntarily or involuntarily dissolved. Because a corporation is a separate legal entity, it continues to exist irrespective of what happens to individual board members, officers, managers or investors.

Centralized Management is an Advantage of the Corporation

Another advantage of the corporate form is that it features centralized management. The board of directors formulates all policy and management decisions, and the corporation's officers carry out those decisions. Shareholders cannot make decisions that bind the company simply by virtue of their investments in it.

A Corporation Features Easy Transfer of Ownership

As a general rule, shares of stock in a corporation are freely transferable. Investors may purchase or sell at will without disrupting the operations of the business or dissolving the entity. This is not true, however, of a close corporation, where a shareholder's agreement may restrict the alienability of shares.

Double Taxation is a Disadvantage of the Corporate Form of Business

One of the major drawbacks of the corporate form is "double taxation." The profits of the business are taxed at the corporate level before dividends are distributed to shareholders. The shareholders are then taxed again on the dividends they receive. This may prove to be a very unattractive feature for the owner of a small business.

Subchapter S-Corporation Offers Pass-Through Taxation for the Small Business Owner

Because of the double taxation characteristic of the general business corporation, the owner of a small business could consider forming a subchapter S-corporation. The "S-corp" offers pass-through taxation at the federal level. In other words, profits are not taxed by the federal government until after they are distributed to the owners (of which there cannot be more than 75). Taxation at the state level varies for a subchapter S-corporation.

The S-corp offers pass-through taxation while retaining other advantages of the corporate form, including limited liability, continued existence and centralized management. Obviously, if a small business owner chooses to incorporate, he or she will have to deal with more paperwork than a simple sole proprietorship would require regardless of the corporate form he or she chooses. The advice and counsel of a business attorney and tax accountant would be beneficial in making those decisions.

The copyright of the article Pros and Cons of Incorporating a Small Business in Business Associations is owned by Suzanne Bechard. Permission to republish Pros and Cons of Incorporating a Small Business in print or online must be granted by the author in writing.