When forming your company, you will be faced with the decision of how what type of entity to decide for tax purposes. The three top choices are generally a "C Corporation," an "S Corporation," or an LLC. Here we'll touch on the pros and cons of a C Corp.
Just what is a C-Corporation anyway?
A C Corporation is any corporation that is taxed separately from its owners — it is legally viewed as an individual entity. All businesses that incorporate are automatically C Corps unless they elect otherwise.
General benefits of a C-Corp
If you need a lot of start up or expansion capital, it is easier to raise because the corporation has stocks to sell. This will save you from dipping into your own personal finances. There is no shareholder limit set by the IRS; the only requirement is that once the corporation has 500 shareholders or $10 million in assets it's required to register with the Security Exchange Commission. BUT…keep in mind that state laws can vary, so check those out to see if there are any restrictions.
If you intend to eventually take the company public, it must be a C Corp or an LLC to be traded on the national exchange. An LLC, you may say? Yup. An LLC can fill out IRS Form 8832, "Entity Classification Election", to change how they will be classified for United States income tax purposes.
Similar to an LLC or S Corporation, a C Corp means there is limited liability for the shareholders, directors, officers and employees (again, this can vary by state so check the local laws). If the corporation is sued, the shareholders are only liable to the extent of their investments in the corporation and their personal assets are not on the line. Also, any debts incurred by the corporation are the corporation's responsibility.
Taxes – The highs and lows
Taxes are where we are going to find the biggest differences between C Corps and S Corps. Let's talk about the good first.
Shareholders of C Corps can get health coverage on a tax free basis as the corporation can fully deduct its premiums. Other fringe benefits are also deductible (like disability insurance, life insurance and company cars) and are not considered taxable income to the employee.
For small businesses, a C Corp could be advantageous because the first $75,000 made would be taxed at a lower rate than other corporations.
C Corps also have the ability to accumulate earnings for future expansion at a lower tax cost than other types of entities.
Now on to the drawbacks…
Double taxation
Whenever you talk about C Corps, the first thing people bring up is double taxation. Profits are first taxed to the corporation, then, when they are distributed to shareholders in the form of dividends they are taxed again. The corporation cannot deduct dividend distributions. You pay personal income tax on the money you pay yourself, and any remaining profits are taxed at the corporate rate.
There are ways to avoid getting hit hard with double taxation…but beware. Some are legitimate but some will bring unwanted attention from the IRS. Some corporations will pay their shareholder employees higher salaries as opposed to distributing income as dividends. The IRS knows about this trick and will often audit corporations stating that the salaries are not reasonable compensation.
If you ever plan on selling your company, know that you'll pay taxes on that money as well.
Lastly, there is no deduction of corporate losses; shareholders cannot deduct losses on their personal tax returns.
Requirements, requirements, requirements
Starting a C Corp can be confusing, and expensive as most likely you'll need to hire outside help. There are a lot of legalities to take care of — you have to write and pay for the Articles of Incorporation, write the by-laws and shareholder agreement, know what permits, licenses and insurance are required, and pay separate state fees in which the corporation operates.
C Corps generally have more paperwork to file. There are requirements to hold formal board and shareholder meetings and keep accurate minutes of these meetings (even if you are the single shareholder). The instructions for Form 1120 (US Corporate Income Tax Return) outline the specific instructions on the necessary record keeping.
When it comes to these requirements and tax forms, ensure you are following the rules by the book. C Corps experience more government oversight due to complex tax rules.
If you need any assistance with tax planning, contact us. We can help you get the best tax treatment available for your situation. Call us at 888-727-8796 or email info@irsmedic.com.
