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What is 'Incorporation'

Incorporation is the legal process used to form a corporate entity or company. A corporation is a separate legal entity from its owners. Corporations can be created in nearly all countries in the world and are usually identified as such by the use of terms such as "Inc." or "Limited" in their names. It is the process of legally declaring a corporate entity as separate from its owners.

BREAKING DOWN 'Incorporation'

Incorporation has many advantages for a business and its owners, including 1) Protects the owner's assets against the company's liabilities 2) Allows for easy transfer of ownership to another party 3) Achieves a lower tax rate than on personal income 4) Receives more lenient tax restrictions on loss carry forwards 5) Can raise capital through the sale of stock.

Throughout the world, corporations are the most widely used legal vehicle for operating a business. While the legal details of a corporation's formation and organization differs from jurisdiction to jurisdiction, most have certain elements in common.

Creation and Organization of Corporations

Incorporation involves drafting an "Articles of Incorporation," which lists the primary purpose of the business and its location, along with the number of shares and class of stock being issued, if any. Companies are owned by their shareholders. Small companies can have a single shareholder, while very large and often publicly traded companies can have several thousand shareholders. As a rule, the shareholders are only responsible for the payment of their own shares. As owners, the shareholders are entitled to receive the profits of the company, usually in the form of dividends. The shareholders also elect the directors of the company.

The directors of the company are responsible for day-to-day activities. They owe a duty of care to the company and must act in its best interest. They are usually elected annually. Smaller companies can have a single director, while larger ones often have a board comprised of a dozen or more directors. Except in cases of fraud or specific tax statutes, the directors do not have personal liability for the company's debts.

Other Advantages of Incorporation

Incorporation effectively creates a protective bubble, often called a corporate veil, around a company's shareholders and directors. As such, incorporated businesses can take the risks that make growth possible without exposing the shareholders, owners and directors to personal financial liability outside of their original investments in the company.

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