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Are you thinking about creating a C corporation for tax benefits? Maybe you’re interested in forming one but don’t know how. Starting one is a complicated process, especially if you’re unsure if it’s the right decision for your brand.
If you’re interested in learning more about C corporations, keep reading for additional information.
What is a C Corp?
A C corporation is a way a business is legally recognized for tax and regulatory purposes. It refers to the way the company ownership is structured. A C Corp has multiple owners, and most are larger businesses with several shareholders and investors.
A C corporation is structured to allow all owners and shareholders to be taxed apart from the company. The C refers to the subchapter in the IRS tax code that governs these types of corporations.
Benefits of Forming a C Corp
C corporations are common due to several advantages that include some tax breaks.
- Limited liability – Business liabilities are separate from those of the owners, shareholders, and investors. You are not liable for claims against the business and vice-versa.
- Independence – The corporation exists apart from its owners. It can continue to exist indefinitely, unlike businesses with a single owner.
- Fundraising – The corporation can raise capital by issuing stock at an Initial Public Offering (IPO).
- Fluidity – Majority ownership is granted to the holder that issues the stock. The stocks are easy to liquid or transfer to new ownership.
- Unlimited shareholders – S corporations are capped at 100 shareholders. C corporations can have an unlimited number.
- International – A C corporation can have international investors, shareholders, and owners, opening it up to new business opportunities.
- Investment – You can accept investments from non-entities; for example, private individuals, partnerships, and other businesses.
- Flexible voting – Shareholders can be issued different value stock and voting rights. Shareholders with the least amount of stock normally have fewer votes. It gives corporation owners the flexibility to control the board’s vote.
- Tax deductions – Employee salaries are tax-deductible, along with their benefits. C corporations can also deduct advertising expenses and rents for company properties.
- Credibility – As an official legal entity, you can immediately gain trust and credibility with your potential customers.
Disadvantages of a C Corp
Creating a C corporation also has a few disadvantages. The structure does tax investors twice when they receive dividends. This is known as double taxation and is due to how the corporation is structured under the IRS tax code. Since a C corp is its own legal entity and for tax and legal purposes is treated like a person, the corporation’s profits are taxed. Dividends to shareholders are paid based on the corporation’s income after taxes. These dividends are also taxed. The investors don’t directly pay taxes twice since the corporation pays the first round of taxes.
In addition to double taxation, companies also have to meet compliance standards for specific legal regulations.
How to Form a C Corp
- Creating a C corporation takes several steps. It’s more complicated to file for a C Corp than an S corporation or LLC. If you’ve decided to form a C Corp is the right direction for your company, there are six steps you need to take.
- Choose a name for the business that reflects its mission, services, or products. The name must be available, not used by others, and meet state legal requirements.
- Register for a business tax i.d. number referred to as an employer identification number (EIN).
- Decide on the C corporation’s board of directors. The number of directors depends on company size and its articles of formation.
- Filing articles of incorporation legally register your C corporation with the state and IRS. There are fees for filing the paperwork that ranges from $50 to $800. The state determines the amount.
- The C-corporation issues stock to founding shareholders.
- Receive the licenses and permits necessary for your state and industry.
It takes several steps to form a C Corp, but it is a good fit for many businesses. Read our complete guide on how to form a corporation for more.
Who a C Corp Might Not Be a Good Fit For
C corporations have advantages, but it doesn’t mean the structure is a good fit for every company. For comparison, head over to our article on the best business structures.
Small Businesses
It’s not designed for small businesses that have fewer than 100 employees. These businesses are usually under single ownership and registered as an S corporation. They receive tax breaks under the S subchapter of the IRS code.
Restructuring as a C corporation may increase the sole owner’s taxes due to double taxation. Most small business owners have contingency plans for their business since they are the sole stockholder. The infinite existence possibility C Corps have does not apply to single ownership or shareholders.
Companies with Low Cash Flow
Low cash flow doesn’t always apply to small businesses; growing companies of any size can experience cash flow setbacks.
It’s expensive drafting and filing articles of incorporation. Most business owners hire a corporate attorney. Costs for legal assistance can range into the thousands of dollars, added to your state’s filing fees.
Double taxation can also take a toll. Multiple owners may cover business and shareholder taxes, but it cuts into their profit margin. A solution is to restructure to a C corporation, but this also means taking on investors and additional shareholders. It may not be the direction you want the company to go.
Independent Owners and Shareholders
Many business owners like their independence. They have a small board of directors, and everyone agrees with the direction the company is taking.
Even companies with more than 100 hundred shareholders may not always benefit from C corporation-associated tax breaks.
C corporations have several rules to follow, and you also have a lot of yearly paperwork to file. Issuing stock at varying values to long time shareholders may also cause problems within the board. If your company prefers to remain independent, there are other tax structuring plans.
Plan on Growing Your Company
You can grow your business without becoming a C corporation. You may have a specific vision your small board agrees with. Adding additional investors will increase cash flow for growth, but you may not be ready for their additional say in the path the company takes.
Differences Between a C Corp and S Corp
C and S corporations have three main differences, but the biggest is taxes. S corporations do not pay taxes, only on personal income. C Corps pay double taxes. You pay taxes on your salary and whatever income you make off of stocks. Along with taxation, formation and ownership are the other primary differences. For a full breakdown, head over to our article on C corp vs. S corp.
Formation
S Corp: Your limited number of shareholders allows them to be more involved with the business. It can strengthen relationships and give you new insights into company management. Employees also have the opportunity to own shares in the company.
C Corp: Creating a C Corp is expensive, but you also have an unlimited number of shareholders to help with the cost. A large number of shareholders can also have disadvantages; they can vote against your decisions.
Ownership
S Corp: S corps have an ownership structure that are limited to U.S citizens and non-citizen resident aliens. It’s also the same for shareholders. A non-citizen resident alien can be an S Corp shareholder, but a non-resident non-citizen cannot be. These limitations also apply to transferring ownership and trading or selling stock.
C Corp: C corporations have no limitations on ownership or stockholders. You also do have a limit on the number of investors. C Corps make it easier to sell the business or transfer ownership.
Taxation
S Corp: S corporations don’t directly pay taxes. Instead, the profit generated by the S Corp flows through to the shareholders’ personal tax returns. The shareholders then pay tax on those profits. Up to 20% of your company income is often deductible, along with any business losses.
C Corp: You are taxed twice as a C Corp, but the 2017 Tax Cuts and Jobs Act capped it at 21%. You can also claim employee health insurance and other benefits, along with 100% of any charitable donations. Your donations cannot exceed 10% of the organization’s annual income.
For more information, head over to our article on how a corporation is taxed.
Differences Between a C Corp and LLC
C corporations and LLCs share very little in common. An LLC is a legal status and not a tax status, unlike a C corporation. Here is a bit more about the major differences. For more, read our full article on LLCs vs. corporations.
Reorganization
LLC: You are required to pay taxes upon the sale of a business. It cannot be transferred or exchanged for stock.
C Corp: C Corps can reorganize free of charge. IRC Section 368 allows for tax-free reorganization. You can sell your business without paying taxes when it’s exchanged for stock.
Stockholders
LLC: As an LLC, you do not have stockholders.
C Corp: You have the potential for unlimited stockholders. The number depends on the stock issues at the IPO.
Ownership
LLC: The ownership can be equally divided to create a business structure similar to a partnership. All owners share equally in the profits.
C Corp: C corporations do not have shared or limited ownerships.
Management
LLC: LLCs can customize their management between members, each with shared responsibility. The downside is that investors may find it more challenging to understand the company’s business plan.
C Corp: Management is more rigid with a C corporation. The board of directors makes the majority of the decisions with input from shareholders. Owners have less control of their company’s goals and direction.
The Last Word
C corps are a very common type of corporation and good for a lot of businesses. Is it right for your business? That’s for you to decide. If you have any questions, don’t hesitate to reach out or contact a financial advisor.
Filed under: Advice Columns
