As you’re deciding on a legal structure for your business, you may come across the term C corporation. But what is a C corporation, and is this legal entity right for you?
What is the difference between a C corp and an S corp?
To understand what a C corp is you also have to understand what an S corporation or S corp is. C corporations and S corporations are not different kinds of corporations. The “C” and “S” indicate how the corporation is taxed under the Internal Revenue Code. The state corporation statute under which you form your corporation and under which its internal affairs are governed makes no distinction between C or S corporations because the state filing office is not concerned with the corporation’s federal tax status.
A C corp s so named because it is taxed under Subchapter C of the Internal Revenue Code. An S corp — as you may have guessed — is taxed under Subchapter S of the Internal Revenue Code. The main difference between being taxed as a C corp or an S corp is that a C corp pays taxes on its income and pays it at the corporate income tax rate. And if the C corp pays dividends to its shareholders, the shareholders pay taxes on the dividends. That results in the corporation’s income being taxed twice — a situation known as “double taxation”.
S corporations do not pay income taxes. Electing to be taxed under Subchapter S with the IRS allows them to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level.
To become an S corporation, all shareholders must sign and file a business IRS Form 2553.
Read more about the difference between S corporations and C corporations.
Why choose a C corporation?
A corporation — whether a C corp or an S corp — is a legal entity that is entirely separate from its owners. If a shareholder leaves the company or sells his or her shares, the corporation will continue uninterrupted in its current form. Corporations can make a profit, be taxed, sue or be sued, enter into their own contracts, and be held legally liable for their actions.
Corporations are attractive because they offer strong protection to their owners from personal liability, but the cost to form a corporation is higher than other structures. Corporations also require more extensive record-keeping, operational processes, and reporting.
Business owners who choose the C corporation do so because (a) they prefer the corporation as an entity over other statutory entities such as LLCs or non-statutory structures such as a sole proprietorship or general partnership, and (b) they prefer to have the corporation taxed as a separate entity or cannot qualify to be taxed an S corporation.
What are the advantages of a C corporation?
Corporations (whether C or S corp) provide limited liability protection to owners — known as shareholders. This means that owners are not typically personally responsible for business debts and liabilities. This is an important advantage of a corporation over a sole proprietorship or partnership.
C corporations may also offer greater tax advantages because of an expanded ability to deduct employee benefits, which are most often used by growing small businesses. There can also be tax savings if the corporate tax rates are lower than the personal rates and/or the corporations are not making distributions of income to shareholders.
Other advantages to becoming a C corporation include:
- Unlimited owners — C corps can have an unlimited number of shareholders. A corporation cannot qualify to be an S corporation unless it meets restrictions for Subchapter S on the number of shareholders.
- Easy transfer of ownership — Ownership is easily transferable through the sale of stock. It can be more difficult to transfer ownership of other entities such as LLCs or limited partnerships.
- Unlimited life — When a corporation’s owner incurs a disabling illness or dies, the corporation does not cease to exist.
- You can raise capital more easily — Additional capital can be raised by selling shares of stock. Stock is generally considered a more attractive investment than ownership interests in other business entities. In addition, a C corporation is not subject to the restrictions of Subchapter S — which for example generally require shareholders to be individuals (thus excluding private equity funds) and US citizens.
- Credibility — Corporations may be perceived as a more professional/legitimate entity than a sole proprietorship or general partnership and are still more familiar to the general public than LLCs.
- Lower audit risk — Generally, C corporations are audited less frequently than sole proprietorships.
- Tax deductible expenses — Business expenses may be tax-deductible.
- Self-employment tax savings — A C corporation can offer self-employment tax savings since owners who work for the business are classified as employees.