The problem, however, is that all the liabilities hang directly on your neck. Your personal assets are at risk as well as your business assets. In a partnership, you can be personally responsible for business liabilities created by your partner.

That's the main reason why most businesses incorporate. Business people want to limit their personal liability. They want to protect their personal assets with the corporate shield.

There are other reasons. Incorporating can foster the free transferability of shares in your business. It can attract investors. Incorporating can allow you to deduct some business expenses from your taxes, such as health benefits, that might not otherwise be deductible. For accounting purposes, incorporating can help separate your business and personal accounting. It can help separate one business from another. For marketing purposes, incorporating could help enhance the image of your company in the business community. Some people just like the sound of "Inc." after their company name. If you're not incorporated, you can't use the label.

Unlimited Stockholders - C corporations can have as many stockholders as they want. Their stockholders can include other corporations or institutional trusts as investors.

Retained Earnings - C corporations can save up money for capital expenditures (like buying a fleet of trucks or buying another company). This is called retained earnings. They don't have to distribute all profits to the stockholders as dividends.

Double Taxation - The big drawback with C corporations is that they are generally taxed twice on their profits. The corporation pays the corporate tax. Then, the stockholders pay dividends tax on the same profits when they are distributed to the stockholders. This double taxation might not hurt certain large corporations that might have big tax deductions and hundreds of stockholders never working in the business. But double taxation could be tough on the small business owner who has to survive on those profits. That's why Congress created the S corporation.

The S Election - It is important to remember that S corporation status requires an affirmative election. This involves filing Form 2553 with the IRS. This form must be filed within 75 days of starting your business. If you miss the deadline, you miss the S benefits for that whole calendar year. However, you can elect S for the following year, but, you must do so by March 15 of the following year or you will miss it again.

In an S corporation, all profits and losses pass directly through to the stockholders, just as they do for sole proprietors and partners. The losses can be treated as ordinary losses instead of capital losses. This is important because these ordinary losses can be deducted from ordinary income if you keep your day job or your spouse is working. Yet the S corporation still provides the full liability shield that the C corporation provides. Only the stockholders' investment, the corporate assets, are at risk, and not the stockholders' personal assets.

There are some significant restrictions on operating as an S corporation. An S corporation cannot have more than 75 stockholders. The stockholders must be individuals, not corporations or certain trusts. The stockholders must be U.S. citizens and U.S. residents. The S corporation can only have one class of stock. Its tax year must be the calendar year. Many benefits, such as health and disability insurance, are not deductible to the corporation for tax purposes. All profits are taxed to the stockholders even if the profits are not distributed. There are no "retained earnings" in an S corporation, even if the company wants to save up for capital expenditures. While some observers call these restrictions the "S straightjacket," many business owners are perfectly comfortable operating within these guidelines and enjoy the benefits of operating as S rather than C corporations.

Your accountant is a VIP in the decision whether to form a C or S corporation. Be sure to review this question with your accountant who understands how the decision will affect your business books.