You may think “C Corporations” are for big, corporate businesses. In reality, there are over 1.4 million small businesses organized as C Corps. But what is a C Corp — and more importantly, should your small business be a C Corp?
Let’s break down what being a C Corp means for your business and compare C Corps to other types of business structures.
What Is a C Corp?
When small business owners start their business, they generally choose a legal entity type or type of corporation. The corporate entity type can also be changed throughout the business’ lifetime. Other types include sole proprietorships, limited liability companies (LLCs), and S Corporations.
Your business’ corporation status affects several significant factors: available funding methods, taxation, structure and governance requirements, and whether an owner bears personal liability for business debts and other company liabilities.
We’ll briefly outline these factors, placing a C Corp in the context of other business structure types.
A C Corp offers far greater funding choices than other business structure types. For example, you can issue stock in the company as a C Corp, which other types — such as sole proprietorships and LLCs — can’t do.
Additionally, a C Corp’s number of shareholders is limited only by the available amount of stock. An S Corp can also issue stock, but the number of shareholders is limited to 100. This means that for a business to be eligible for S Corp status, the corporation cannot have different classes of stock.
Suppose you want to use a flexible funding method like Rollover for Business Start-ups (ROBS). In that case, your business must be a C Corp. ROBS allows you to use your qualified retirement funds, such as a 401(K) or Individual Retirement Account (IRA), to fund your small business tax-penalty free. You could use ROBS as a funding source itself or as a down payment for a business loan.
Using ROBS can eliminate or minimize the drawbacks of other funding types. Loans, for example, require you to pay monthly debt payments. Funding types like these can tie up the cash flow needed to run or expand your business. The difference between no debt and monthly debt payments can be especially critical for start-ups.
Loans can also prove challenging to get, especially for start-ups. Lenders often require stringent standards of creditworthiness and history in the business.
Due to the IRS’s requirements on qualified employer securities (QES), your business must be filed as a C Corp to utilize ROBS. Sole proprietorships and LLCs don’t have stock and, therefore, can’t issue QES as needed. At the same time, the specific prohibited transaction exemption ROBS relies on does not apply in an S Corp.
Taxation and Tax Implications
A C Corp is separate from its owners, unlike a sole proprietorship. Its profits are taxed at a corporate rate.
In addition, any money a C Corp pays individuals, such as salaries and dividends, is taxed at an individual income tax rate. This makes C Corp taxation quite different from sole proprietorships, LLCs, and S Corps.
Sole proprietors pay income taxes individually. LLC profits and losses pass to its members (as owners of LLCs are called), who then pay individual income tax on the profits. Similarly, S Corp profits and losses pass to the owners, who pay individual income tax and report their business income or losses on their personal tax returns. S corporations, partnerships, and sole proprietors are each considered a pass-through entity for this reason.
For a business with an LLC corporate status, profits and losses can get passed through to your personal income taxes without facing corporate taxes. However, members of an LLC are considered self-employed, and therefore, must pay self-employment tax contributions toward Medicare and Social Security.
In a C Corp, the corporation pays its own income tax and files a corporate tax return. C Corp taxation, of both corporate taxes on profits and personal taxable income, is often referred to as “double taxation.” This may sound like the taxes paid by C Corps are more than other business structures. But that’s not the case.
“Double taxation” means that both the business entity and the people employed pay taxes. So, the corporate income tax is paid first at the corporate level and again at the individual level.
While some may see double taxation as a downside, a C Corp can actually offer many tax advantages — unlike other entity types. (See the “Tax Notes” section below for an overview.)
With both C Corps and S Corps, personal tax returns are due on any salary drawn from the corporation and from any dividends received from the corporation.
Discussing the tax advantages of various business structure types with an accountant or business consultant is essential for making the best choice for your business.
Structure and Governance Requirements
A C Corp is subject to Federal and state requirements regarding its structure and governance. For example, a C Corp must have a Board of Directors and bylaws. If it has public shareholders, shareholder meetings must be held, and annual reports and financial results must be publicly available.
These requirements can open opportunities for advice and mentorship from potential Board members and other business leaders. By hosting shareholder board meetings and meeting financial requirements, you’ll have the advantage of focusing more on your business as you regularly review its operations and performance.
C Corps legally exist independently of the owner. They have “perpetual existence,” meaning that the corporation continues to exist if the owner retires or passes away. This makes it easier to employ family members or pass the business on to your heirs if you choose to do so.
Generally, an S Corp is also subject to Federal and state requirements. Sole proprietorships and LLCs, on the other hand, are typically not. However, LLCs are subject to other requirements from the Secretary of State’s office.
A C Corp protects business owners from personal liability in case the business incurs future liabilities, such as a debt, a lawsuit, or bankruptcy. You cannot be pursued for your personal assets, although the business assets can be taken to pay a liability.
An LLC and S Corp also offer protection from personal liability and your personal assets, while a sole proprietorship does not. Both C Corps and S Corps offer limited liability protection.
How to Create a C Corp
To create a C Corp, you’ll need to check with your individual state’s Secretary of State’s office to obtain the specific requirements in your state. Generally, the minimum required is a business name and a filing of IRS Form 1120 for corporate income tax. You may also need to publish a notice of intent and pay a filing fee with the Secretary of State.
Depending on your state requirements and business plan, you may also need (or want): articles of incorporation, create corporate bylaws, an Employer Identification Number (EIN), a business trademark, state-specific business licenses, and a sales tax identification number (if you plan on selling items).
Creating a C Corp can be complicated and time-consuming. To err on the side of caution, you may want to consider consulting with a lawyer who can assist you in filing documents.
With a templated articles of incorporation and a small number of shareholders, you may be able to set up a simple C Corp yourself. You can also consult a third-party company specializing in business filing, like MyCorporation. MyCorporation can help entrepreneurs prepare the paperwork and file articles for a C Corporation, register a trademark, file an EIN application, and fulfill any other requirements.
Advantages and Disadvantages
Each business entity choice has its pros and cons, depending on your situation. It’s crucial to weigh these carefully to determine which business entity type makes the most sense for you and your business.
- Increased ability and flexibility in obtaining funding for business growth
- Ability to use 401(K) financing or ROBS (Rollover Business Start-ups), allowing you to start your business tax-penalty and debt free
- Issue unlimited shares of stock
- Unlimited number of shareholders versus restrictions with S Corp stock
- Potentially advantageous tax benefits and tax savings
- Protection from personal liability
- Strong corporate structure, including Board of Directors, bylaws, annual meetings, and financial filings
- Exists in perpetuity, in case of owner retirement or passing away
- Potential tax disadvantages, depending on the situation
- Subject to numerous Federal and state requirements
- Management structure and business decisions must abide by bylaws and other requirements. (Those who seek a more flexible structure and hands-on decision-making with no requirements might view this as a drawback.)
C Corp’s can offer multiple tax advantages for businesses. Here’s a brief overview:
First, a C corporation’s corporate tax rate can be less than individual income tax rates, depending on the tax bracket.
Second, C Corp’s are allowed to deduct 100 percent of health insurance costs paid for their employees from their taxes. Costs paid for medical reimbursement plans are also deductible. Suppose your company has medical expenses not covered by insurance. In that case, a C Corp structure can allow you to set up a plan that deducts all those expenses. To reduce your tax liability, you can deduct other business expenses as well, such as equipment or service costs.
Third, profits do not pass through to the owners and, therefore, will never affect your individual tax bracket.
Fourth, C Corp’s can use many strategies to reduce corporate taxes. One is the ability to take virtually unlimited capital and operating losses. As a result, the IRS will not scrutinize the returns if you report losses over many consecutive years. You can carry losses forward or backward and apply them against other tax years, which can substantially decrease tax bills. This can be especially important for a start-up that may take substantial losses in the first year but wish to carry them forward to future years.
A C Corp can reduce its taxable profits by electing to pay out a large percentage of profits (or even all profits) in salary and bonuses. The employees would pay only individual income taxes. A C corp is a completely separate tax entity in the eyes of the IRS, meaning that your business can take tax deductions.
Finally, C Corp’s has some flexibility in deciding which year bonus money will be taxed. Their fiscal years do not need to follow the calendar, unlike sole proprietorships, LLCs, and S Corps. As a result, C Corp’s can “income shift,” deciding which year to be taxed on bonuses paid.
You should choose a C Corp if you…
- Want flexible funding options, such as ROBS or stock
- Can benefit from the entity’s tax advantages
- Can benefit from the required structure and governance
- Want personal protection from any company liabilities