The reason why most businesses choose to incorporate is because it offers protection to the shareholders of their personal assets. Shareholders have peace of mind knowing that the only financial risk they potentially face is the amount they invest in the corporation. A sole proprietor or partnership carries with it a lot of possible exposure to personal assets if faced with large debts that the business can’t pay. Creditors can look to the individuals’ family home and bank accounts to satisfy debts and other liabilities. Not so with a C corporation. All debts and liabilities are those of the corporation solely. Personal assets of the shareholders cannot be reached.
Piercing the Corporate Veil
corporate formalities and was using it to avoid liabilities and commit fraudulent acts. If the corporate veil is pierced, then the shareholders’, members’ or owners’ personal assets can be reached. Small corporations are more likely to have this happen as it can be more difficult for them to keep up with all of the formalities. An important and easy way for small corps to avoid any piercing is to avoid comingling of assets and to keep the accounts and assets of the corporation completely separate from individual accounts. Those corporate accounts must never be used for personal reasons.
Because a corporation is its own entity, it can continue to exist long past the original shareholders lifetimes, since shares can freely be transferred. Transferring shares has less and easier to understand tax implications than the transferring of a partnership or proprietorship interest. It does not matter if a shareholder, director or officer leaves the company, or dies. A deceased shareholder’s shares go to the heirs of the shareholder quite easily. The corporation will continue on and can only end when it is dissolved by the shareholders. So in essence, the corporation can exist indefinitely. This is a major advantage as it provides stability and is more attractive to investors. The longer the corporation exists, the better likelihood of success and a return on investment.
While corporations have some tax drawbacks, there are some advantages. Losses to the corporation may be tax deductible. A corporation can set up fringe benefits for its employees such as paying for health insurance and contributions to employee retirement plans and can deduct the costs while those benefits to the employees won’t be taxed on the benefit as income. The first $75,000 a C corporation makes is taxed at a lower rate than other kinds of corporations. This is a huge benefit for smaller corps.
Obtaining Investment Capital
Corporations are attractive to investors for a number of reasons. There are no limits on the number of shareholders and the protection of their personal assets can make investors feel more comfortable investing in corporations. In addition, corporations have a well-organized control structure with specialized roles and in turn, those roles are all governed by a large number of corporate statutes and regulations. They are seen as less risky than LLCs as LLCs are not highly regulated and are usually operated under general rules or a short operating agreement which may not be very detailed. Although corporations are highly regulated, their structure and hierarchy still allows for flexibility as certain investors can take part in major decisions and elections which is often important to investors. There are potentially less tax implications to investors, especially foreign investors. LLCs have a flow through taxation which does not exist for corps.