Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Incorporation

What it is:

Incorporation means to form a corporation. A corporation is a legal form of business organization. It is sometimes referred to as a "C Corp" in reference to a section of the IRS code governing corporate taxes.

How it works (Example):

Corporations have several distinguishing characteristics.

  1. A corporation is owned by shareholders, and their ownership is represented by shares of stock.
  2. A corporation has a board of directors, which is a group of people elected by the shareholders to oversee the corporation's managers and represent the best interests of the shareholders.
  3. They have unlimited lives; that is, corporations don't "die" or "expire" unless they do so intentionally or go bankrupt and liquidate their assets.
  4. The shareholders have limited liability. That is, the liabilities of the corporation do not extend to the shareholders. If the corporation goes bankrupt or defaults on a loan, the corporation's creditors almost always cannot repossess the shareholders' personal assets or seek repayment from the shareholders themselves.
  5. Corporations pay income taxes on their taxable income, even if they distribute some of that income directly to the shareholders.
  6. Corporations are legal entities that exist separate and apart from their shareholders. In fact, they are usually afforded the legal rights of people. That is, they can own assets, borrow money and sue or be sued.

Why it Matters:

To incorporate means to form one of the dominant business structures in the United States, and this is often because the largest advantage to incorporating is the limited liability the structure brings to the company's owners. Incorporation's limited liability encourages investment and in turn makes it easier to raise equity capital, among other things. However, incorporating a business means agreeing to more governance and regulation than other business forms, and this makes them more expensive to operate.

One of the biggest complaints about incorporating is the double taxation of profits it brings: the corporation must pay income taxes on its taxable income, and shareholders also must pay income taxes on that same income if the corporation pays that income out as dividends.

Although some corporations are nonprofit entities, perhaps the most important, prominent and sometimes controversial duty of a corporation is to enhance shareholder value. This duty is most often executed through the maximization of profits.