Incorporation Definition

As the name suggests, incorporation is the process of forming a corporation. But what does this term really mean in business? Furthermore, what are the advantages and disadvantages of incorporation? This guide walks through what incorporation is, so entrepreneurs can evaluate if it’s the right choice for their entities. 

What is incorporation?

Incorporation is the legal process of forming a corporate company or entity. This process results in the separation of the company’s (corporation’s) income and assets from those of its owners or investors. 

Incorporation Process

Forming a corporation involves filing Articles of Incorporation (or the state’s equivalent form) with the Secretary of State in the state where the company will do business. Below, the “Steps to Incorporate” section will cover this process in more detail.  

Incorporation Benefits

Incorporation offers several advantages to business owners, but there are some disadvantages to consider, too. 

Advantages of Incorporation

Just a few of the advantages of incorporation include: 

• Limited liability
  • Because cash flow and assets of a corporation are legally separate from those of its owners, the owners’ assets are protected from the liabilities of the company. 
• Creating a defined corporate structure enables the business owners to clarify ownership and responsibilities
• Easy transfer of ownership / interests
• Corporations can typically acquire funding / loans more easily
• Boosted credibility in the eyes of potential investors, customers, etc. 
• The life of a corporation can extend beyond the lives of its original founders
  • By changing board members, directors, etc., a corporation can continue indefinitely. 
• Advantageous tax rates
• Ability to raise capital through sale of stock
  • Incorporating gives a business the legal right to sell stock. 

Disadvantages of Incorporation / Considerations

While the benefits of incorporation are numerous, there are also a few potential downsides or pitfalls entrepreneurs need to consider: 

• Incorporating can be costly thanks to fees
• Forming a corporation involves lots of paperwork
• Corporation company profits are often double-taxed
  • Corporations are first taxed on their net taxable income, then business owners are taxed on their salary and dividends. 
• Corporations are subject to strict compliance regulations

Types of Corporations

Not all corporations are created equal. There are a few different types of corporations, including C corporations, S corporations, and nonprofits.

C Corporation​

A C corporation (C corp) is a type of corporate structure that offers the strongest legal protection to its owners. Filing as a C corporation is a legal procedure that allows corporations to profit and be taxed accordingly. Although C corporations protect their owners from personal liability, they need extensive record-keeping, reporting, and operational processes.

Shareholders relation to the C Corporation

C corporations are structured so that if a shareholder decides to leave the company or sell their shares, the corporation itself can remain undisturbed. The lives of shareholders and the corporation are completely independent of each other. Because of this structure, C corporations are a great choice for medium- to high-risk businesses or businesses that plan to be sold or “go public.”

S Corporation​

An S corporation (S corp) is designed to avoid the double taxation issues of C corporations. Taxes can be passed directly through the owners’ personal income, avoiding corporate tax rates. Most states recognize S corps the same way that the federal government does and tax shareholders according to those laws. 

S Corps are not all taxed the same

Since each state can set its own laws for corporations, not all S corps are equally taxed. For example, some states do not recognize S corporations, taxing them like C corporations. In other cases, certain states might tax S corporations in profits above a specified limit.

Nonprofit Corporation​

A nonprofit corporation is designed to do charitable, religious, educational, literary, or scientific work. Nonprofit corporations work for the public and can receive tax-exempt status, which means they do not pay state or federal taxes for any income or profits.

In addition to following rules that are very similar to a C corporation, they also follow a special set of rules about what to do with any profits.

Steps to Incorporate

To incorporate a business, an entrepreneur will follow these general steps: 

1. Name the corporation
2. Appoint directors
3. Choose a registered agent
4. File the Certificate of Incorporation / Articles of Incorporation
5. Create corporate bylaws
6. Draft a shareholder agreement
7. Issue shares of stock
8. Apply for necessary business permits or licenses
9. File for an EIN and review tax requirements
10. Submit the corporation’s first report

This process will vary depending on the state and the type of corporation being formed. Learn more about incorporation formation here. 

Incorporation Examples

Examples of companies that are incorporated include those with names that include labels such as: 

• Incorporated
• Inc.
• Corporation
• Corp.
• Any abbreviation of the word “corporation” or “incorporated”

ZenBusiness Can Help

Turning a business idea into a reality is exciting, but it’s a detailed process. ZenBusiness specializes in helping small businesses get started on the right foot. From our formation plans to compliance, they’ve got all the worry-free services a business owner needs to start, run, and grow their company. Reach out today!