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Overview: Corporations

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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.

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