For well over two hundred years, the corporation has been the organization of choice for most business enterprises. The corporate characteristics of limited liability, continuity of life, transferability of interests, and ability to enter contracts provide the reasons that the corporate form has maintained such long-term popularity. These characteristics make the corporation particularly suitable for raising capital from diverse sources.
In our experience, the reason most small business people initially consider incorporating is to enjoy the protection of their personal assets that is afforded by the corporation’s limited liability characteristic. Simply put, a business owner has “limited liability” if the business entity, and not the owner, is responsible for the debts and obligations of the business. In other words, if the business should get into financial difficulty, only the business assets and not the personal assets of its owners are at risk. It is essential that the corporation adhere to certain formalities in order to maintain limited liability for its owners. These formalities include doing business in the corporate name, keeping up with paperwork requirements, such as conducting annual meetings and maintaining minutes of corporate meetings, perhaps most significant, adequately capitalizing the business.
Unlike corporations, partnerships and sole proprietorships do not provide their owners with limited personal liability for business debts. This means that owners’ personal assets are subject to claims of creditors of those businesses, who can attempt to collect debts of the business from personal assets of the owners.
Continuity of Life
A corporation is said to have “continuous life,” because it does not cease when its owners change or die. Unlike partnerships, the corporate business entity goes on until it is dissolved by some deliberate action of the owners or governmental authorities.
Transferability of Interests
Ownership of a corporation is evidenced by shares of stock, which are freely transferable by the holders in the absence of some agreement among them restricting transfer. The purchaser or transferee of stock steps into the shoes of the prior owner and will be entitled to whatever dividends and voting privileges accompany the shares. In contrast, the transferee of a partnership interest only gains the right to share in partnership profits and may not be entitled otherwise to participate in the partnership’s business.
Ability to Contract
A corporation is an distinct legal entity that is separate from the people who own and manage it. Corporation and tax laws view the corporation as a legal “person” that can enter contracts, incur debts, sue and be sued, and pay taxes apart from its owners.
Corporations differ from other business structures in the way they are taxed. The corporation itself must file income tax returns and, unless it has elected subchapter s status, pay corporate income tax on its profits. In contrast, partnerships, sole proprietorships, and most LLCs are not themselves taxed on business profits, although both partnerships and limited liability companies must file tax returns. The profits of partnerships, sole proprietors and LLCs “pass through” to the owners of the business, who report business income or loss on their personal 1040 tax returns.