Attorneys at Law

Disclaimer: The information contained in this FAQ is provided for general information purposes only and is not intended to be a legal opinion, legal advice or a complete discussion of the issues related to corporate formation. Every individual's factual situation is different and you should seek independent legal advice from an attorney familiar with the laws of your state or locality regarding specific information.

A corporation is a legal entity, chartered under state law, that is separate and distinct from its shareholders and officers and that has the unique quality of unlimited life. It is a vehicle designed to foster investment by insulating the investors from the liabilities of the business. Indeed, limited liability is the principal reason most businesses incorporate.

While most small businesses incorporate for the express purpose of achieving limited liability, there are certain circumstances under which the officers and, occasionally, stockholders can nevertheless be liable for a corporation's debts. These include circumstances when the corporation's creditors are allowed under common law to "pierce the corporate veil" (i.e., to pursue corporate officers personally who have used the corporation as a front for perpetrating a wrong, or who have used it as an incorporated pocketbook or alter ego), or to sue the principal stockholders directly for unpaid wages and employee benefits (as in New York and Connecticut). Accordingly, in attempting to achieve limited liability, it is important not only that the corporation exist and be in good standing (i.e., have paid all of its franchise taxes), but also that it be operated in a manner which indicates that it is truly separate from its stockholders' personal finances.

Also, certain kinds of professionals—architects, physicians, attorneys, etc.—are prohibited by law from limiting their liability through incorporation. Professionals who operate service or other small businesses are virtually certain to be sued personally in any case in which the corporation is sued and should be prepared to front defense costs in the event that the corporation lacks the resources to do so.

Finally, incorporation offers little protection against negligence for a sole proprietor. A person who personally performs work can not interpose the corporation as a shield against his or her negligence in performing that work. For example, if you were driving to meet a client and ran a stop sign, hit another car and injured its occupant, the fact that you were working for the corporation will not prevent you from being sued personally for your personal negligence. (The corporation will be liable as well, under the legal doctrine of respondeat superior, which holds employers responsible for the acts of its employees.)

The cost of incorporating is small—usually under $750, plus the cost of qualifying as a foreign corporation in each state in which the corporation does business (another few hundred dollars). The annual fees of maintaining the corporation include franchise taxes, registered agent's fees and license fees. A corporation, which is a taxpayer distinct from its stockholders, must also file separate tax returns at both the state and federal levels. These filings may require the services of an accountant, adding an additional cost element.

As noted above, incorporation may be of questionable value for service professionals who are unable to create liabilities for which the corporation alone will be responsible. Such professionals may derive optimum benefit from continuing to operate as sole proprietors or partnerships—and purchasing lots of insurance.

Copyright (c) 1996 Hilary Miller

We can help you establish a firm, legal base for your new business. From the Business Plan through Incorporation, Bylaws, Shareholder's Agreements, Contracts, and other planning measures, we work with you to see that all you have to worry about is running things. Call us at (301) 924-4400 or e-mail us to set up an appointment.