While incorporation requires more paperwork and expense than sole proprietorship,
it does give you one critical benefit - protection from liability.
A corporation is a separate legal entity from the person (or people) that owns it. The
corporation, not the owner, enters into business deals, owns property, borrows
money, and engages in other business activity. Because the corporation is involved
in these business deals, you and your personal assets will, in many cases, be
protected from liability if something goes wrong.
For businesses with more than one owner, incorporating can often protect you from
the actions and misdeeds of your co-owners. This is unlike a partnership, where
each partner is personally liable for the business-related actions of all the partners.
There are other benefits to incorporating. You can gain access to benefit plans only
available to corporations. It also creates a positive image for your company - when
you are trying to raise capital, obtain credit card merchant status, win certain kinds of
new customers, or do business in foreign countries, incorporation can be important
for appearance's sake.
You should be aware that corporate liability protection is not absolute. If you are
interested in incorporation because of the protection it promises, look at the
following exceptions:
- It cannot protect you from your own bad acts. Being a director of a
corporation does not protect you from personal liability from the wrongs you
personally commit. For example: You run a package delivery service and
you fill in for a driver who has called in sick. If, in the process, you run into a
busload of people, you are personally liable for the damage.
- It cannot protect you from things you personally guarantee. Banks and
some corporate creditors often require personal guarantees from people in
a corporation. So if your business were to fail, you would be personally
responsible for repaying these debts. In addition, you don't want to become
personally liable inadvertently... so be certain your name, title, and
company name are on anything you sign.
- It cannot protect you from owing governmental trust fund taxes (withholding
taxes and sales taxes). When taxes are held in trust, all officers and
anyone who has check-signing authority are jointly liable to the government
for these taxes. That means that as a principal, you cannot hide behind the
corporation and will be personally liable for these taxes if they are not paid.
- It cannot protect you from some state laws. New York, for example, has a
law which says that the ten largest shareholders of a corporation are
personally responsible for unpaid employee wages. If a restaurant operates
for three years and goes out of business, the owners and principals are
personally responsible for any unpaid salaries.
- It cannot protect people in certain professions. Professionals including
doctors, lawyers, and accountants are personally liable in any lawsuit.