A corporation is considered by federal and state law to be an artificial legal entity that exists separately from the people who own, manage, control, and operate it. For example, it can make contracts and pay taxes, and it is liable for debts.

A business corporation issues shares of its stock, as evidence of ownership, to the person or persons who contribute the money or business assets that the corporation will use to conduct its business. Thus, the stockholders or shareholders are the owners of the corporation, and they are entitled to any dividends the corporation pays and to all corporation assets -- after all creditors have been paid -- if the corporation is liquidated.

Following are the main Pros and Cons of operating a small business as a C Corporation:

Pros:

• Limited personal liability: The main reason most businesses incorporate is to limit owner liability to the amount invested in the business. Generally, stockholders in a corporation are not personally liable for claims against the corporation and are, therefore, at risk only to the extent of their investment in the corporation. Similarly, the officers and directors of a corporation are not normally liable for the corporation's debts. Incorporation also protects owners from personal liability regarding lawsuit damages not covered by the corporation's liability insurance policies. However, owners need to follow several corporate formalities and requirements to protect the limited liability benefit. For example, limited liability may be lost if owners fail to elect directors, appoint of officers, or maintain the separate legal existence of the corporation. Refrred to as "piercing the corporate veil", if a corporation is neither adequately capitalized nor properly operated to protect the interests of creditors, the courts can take away the veil of limited liability that normally protects the stockholders.

• Income splitting: A corporation, you may overall profit between two or more taxpayers so that none of the income gets taxed in the highest tax brackets. The total tax paid by the two tax­payers -- the owner and the corporation -- may be less than if all of the income were taxed to owner, as in a sole proprietorship.

• Tax break for dividends received by a corporation: C corporations can deduct at least 70% of the dividends they receive from stock investments from their federal taxable income.

• Ability to use fiscal tax year: Unlike unincorporated businesses, which generally must use the calendar year as their taxable year, or else must give up the tax benefits of using a fiscal tax year if they do adopt a fiscal year, a C corporation (but not an S corporation) can generally adopt any month of the year as its year-end, for tax accounting purposes. Careful choice of a corporation's taxable year-end can often be a way of reducing corporate income taxes.

• Continuous existence: Unlike a sole proprietorship or partnership (or, in most states, a single-member limited liability company), a corporation has continuous existence and does not terminate upon the death of a stockholder or a change of ownership of some or all of its stock. Creditors, suppliers, and customers, therefore, often prefer to deal with an incorporated business because of this greater continuity. A corporation can be terminated by mutual consent of the owners or even by one stockholder in some instances.

Cons:

• Significant Administrative Requirements: In addition to having more paperwork and recordkeeping requirements -- in order to maintain the corporate veil of limited liability -- corporations must ensure they meet all annual report filings and, in some circumstances, SEC requirements as well. Incorporation takes a lot of organization and maintenance.

• Of the major types of legal entities, C corporations and S corporations have the most burdensome requirements with regard to the formalities of formation and existence. In addition to filing articles of incorporation with the state where it is organized, it must also adopt bylaws, elect a board of directors, hold organizational meetings as well as regular board and shareholders' meetings, and keep minutes of such meetings. In addition, each state in which it operates has its own corporate requirements, such as qualifying to do business, that must be observed.

• Cost of incorporating: Incorporating requires payment of filing fees required by state agencies for articles of incorporation, name reservation, and issuing stock, and often for appointing an in-state registered agent to receive legal process.

• Double taxation: C corporations have one major potential disadvantage that usually does not exist for other legal forms of doing business: the problem of potential double taxation of the earnings of the corporation. This problem arises because a C corporation must first pay corporate income taxes on its taxable income. Then, the after-tax earnings may be subject to a second tax on either the individual stockholders, if the earnings are distributed as dividends, or as a corporate penalty tax if the earnings are not distributed as dividends.

The main ways in which a corporation's earnings can be subject to double taxation are:

• Payment of taxable dividends (income that has already been taxed at the corporate level, and is taxed again when paid to the shareholder as a dividend);
• Penalty tax on corporate accumulated earnings; and
• Penalty tax on personal holding company income.