What Is Incorporation?

Incorporation is the legal process used to form a corporate entity or company. A corporation is the resulting legal entity that separates the firm's assets and income from its owners and investors.

KEY TAKEAWAYS:

• The process of incorporation involves writing up a document known as the articles of incorporation and enumerating the firm's shareholders.
• In a corporation, the assets and cash flows of the business entity are kept separate from those of the owners and investors, which is called limited liability.
• Though incorporation, a company's tax liability is also treated differently that that of a sole proprietorship or partnership.

Understanding Incorporation:

A company does not need to be incorporated to operate a business. Business owners may elect to operate as a sole proprietorship or a partnership instead. These two legal business formations treat company debt and taxes differently than compared to an incorporated entity.

Another primary difference between legal entities and one of the most important reasons a company may want to incorporate is for the advantage of issuing stock. When a company incorporates, it gains the ability to share ownership of the company by issues shares of stock. Whereas a sole proprietorship or partnership is usually only owned by those operating the company, incorporating allows a business owner to sell an ownership stake in part of the business.

Advantages and Disadvantages of Incorporation:

Cons of Incorporation:

The primary drawback of an incorporated business is the operating constraints to maintain its incorporated status. Companies must adhere to their bylaws and must ensure it meets filing, reporting, and other ongoing requirements. An argument can be made that since an incorporated entity's tax filing is separate from any individual's, there is also an administrative burden angle when preparing multiple tax returns.