Whether you are setting up a new company or you have been in business for years, you and your attorney should evaluate which legal structure is best to meet your needs, but this is not where the decision ends. You will also want to work with your Smith Schafer advisor to determine which structure works best for your tax situation. It could influence how you engage in business transactions, protect yourself against liability and minimize tax.
Choosing the right type of entity structure for your business can be a complicated process. Numerous factors go into making this decision. It is critical to understand the business structure options available to you, each option’s tax implications, and when each is most appropriate for your business. We provided a summary of C Corporations and the tax advantages and disadvantages.
What is a C Corporation?
A corporation receives a certificate of incorporation and is considered legally separate from owners. It is the most complex and expensive entity to create and maintain. The owners elect a board of directors to oversee the company. C Corporations can be either privately held or publicly held.
Tax Advantages of a C Corporation
- Unlike S Corporations, there are no restrictions on ownership, whose shareholders must be domestic and are limited to no more than 100 shareholders.
- They can raise capital by selling shares of stock. Investors may be more willing to give a business money in exchange for stock shares rather than a promissory note.
- The potential to lower your tax bill exists. C Corporations are taxed a special corporate tax rate, which is different, and often lower, than the individual tax rates for a sole proprietorship. The Tax Cuts and Jobs Act reduced the C Corporation tax rate to 21 percent.
- C Corporations offer more flexibility in choosing a fiscal year-end date rather than following a calendar year.
- C Corporations’ audit potential may be lower as there is no income or loss pass-through like other entity types.
Disadvantages of a C Corporation
- C Corporations are often looked at unfavorably due to double taxation. The income earned by a corporation is subject to income tax at the corporate tax rate. Any dividends paid out to owners are then taxed at the owner’s individual tax rate. However, if a business is in growth mode and reinvests its profits back into the company, double taxation may not be an issue rather than paying out dividends.
- Example: Assume a corporation had $100,000 of net income in 2020 and issued a dividend of $10,000 to each of its two owners. The corporation is taxed on its $100,000 of net income, and the owners are each taxed on their dividend on their individual tax returns.
- Business owners may, in turn, end up paying more in taxes. C Corporations do not have access to the same credits that individuals have on their returns. Owners cannot reduce their personal tax liability with losses sustained by the corporation. Those losses are carried forward on the corporate level until they can be used.
- The costs of starting and maintaining a C Corporation are often more expensive than the costs associated with S Corporations or LLCs.
- Internal Revenue Service – Publication 542 – How C Corporations are Taxed
- U.S. Small Business Administration – How to Choose a Business Structure
- Smith Schafer – Tax Reform Affecting C Corporation Tax Planning
When selecting or considering a new legal structure, business owners should always review their options with your Smith Schafer professional. For additional details on legal entity analysis and selection or to learn more about how we can help, please contact a Smith Schafer professional. We look forward to speaking with you soon.