In the corporate landscape, C corporations stand out as a common corporate structure for entrepreneurs. Small business owners and individuals in finance or HR roles need a comprehensive understanding of what sets C corporations apart.
Here, we unravel the complexities of C corps, shedding light on their structure, tax implications, and the liability protections they provide to businesses.
Key Takeaways
- C corporations are a tax classification that separates business income from owners, offering limited liability protection but subjecting profits to taxation at both the corporate and shareholder level.
- The 21% flat corporate tax rate makes C corps attractive for companies retaining earnings for growth, while fringe benefits offer tax advantages not available to other business organizations.
- C corps work best for businesses seeking venture capital, planning to go public, or needing unlimited shareholders—the structure many companies use when scaling beyond initial startup phases.
What Is a C Corp?
A C corporation, commonly referred to as a C corp, stands as a separate legal entity from its owners or shareholders. This distinction provides limited liability protection, meaning the personal assets of the shareholders are protected in the event of business debts or legal actions.
The C corp business structure is a popular choice for entrepreneurs and businesses due to its ability to attract investment, its scalability, and its tax benefits.
How Does a C Corp Work?
Next, let’s explore how this entity type functions in practical terms. Understanding the operational structure of a C corp can help you better grasp how, exactly, it works and how it might apply to your business.
Operational Structure
A C corp is a type of corporation that is considered a separate legal entity from its owners or shareholders. This means that the business itself holds its own rights, independent of its founders or shareholders.
Structurally, a C corp is organized with a board of directors who make significant decisions and officers who handle the daily operations. These roles are outlined in the corporate bylaws, which serve as the company’s internal rulebook.
Additionally, a C corp can issue stock and have an unlimited number of shareholders. The issued shares of stock represent ownership in the corporation and can be of different classes, with each class of stock having its unique rights and privileges.
Legal Requirements
Starting a C corp involves a few steps. First, entrepreneurs must file the articles of incorporation (also called a certificate of incorporation) with the Secretary of State in the state where the business will be headquartered.
This document includes essential details such as the business name, purpose, and information about stock issuance. There’s typically a filing fee associated with this. Once registered, a C corp must appoint a registered agent—someone who receives official legal and tax correspondence for the business.
C corps are required to file annual reports and adhere to specific state laws, which may vary from one state to the next. For instance, Delaware’s renowned business-friendly regulations attract many companies to incorporate there. Delaware corporations benefit from well-established corporate law and a business court system designed specifically for corporate disputes.
Paying Yourself
One of the many decisions small business owners face when running a C corp is determining how to compensate themselves. Generally, owners who are actively involved in the business draw a salary as employees.
This compensation is subject to personal income tax. Additionally, they might receive shareholder dividends, which are distributions of the company’s after-tax profits.
Download the state-by-state HR guide
Streamline your hiring process with a list of employment requirements in every state and eliminate the guesswork.
C Corporation Taxation: Key Considerations
Perhaps one of the most-discussed characteristics of a C corp is its tax treatment, particularly “double taxation.” The Internal Revenue Service treats C corporations as separate taxable entities under the Internal Revenue Code, creating both opportunities and challenges.
How C Corp Taxation Works
Here’s how it works—a C corp, as a separate legal entity, pays corporate income tax on its business income at the corporate level. The current federal corporate tax rate is 21%, significantly below the top individual rate of 37%.
Ownership through shares means individual shareholders pay taxes on dividends they receive, while the corporation pays taxes on its earnings first. After the corporation pays its taxes, if it distributes dividends to shareholders, those dividends are considered taxable income and are taxed again on the shareholders’ personal tax returns. This two-layer taxation is what’s referred to as “double taxation.”
One of the many decisions small business owners face when running a C corp is determining how to compensate themselves. Generally, owners who are actively involved in the business draw a salary as employees. This compensation is subject to personal income tax. Additionally, they might receive shareholder dividends, which are distributions of the company’s after-tax profits.
Tax Advantages
While double taxation might seem like a drawback, C corporations offer several benefits that often outweigh this concern:
- Lower Corporate Rate: The 21% federal rate creates meaningful tax savings for companies retaining profits for growth
- Retained Earnings: Keep profits in the company without triggering personal income tax for owners—unlike pass-through entities where owners pay taxes on all income whether distributed or not
- Deductible Fringe Benefits: Health insurance, life insurance, and retirement contributions are tax-free to employees, including shareholder-employees
- Reasonable Salaries: Owner-employees can take salaries that reduce taxable corporate income and convert what would be double-taxed dividends into deductible business expenses
Tax Disadvantages
The main tax challenges include:
- Double Taxation: Profits face corporate tax, then shareholders pay personal income tax on dividends (though qualified dividends face lower rates of 0-23.8%)
- Trapped Losses: Early-stage losses can’t pass through to owners’ personal returns—they create net operating losses usable only against future corporate income
- Asset Sales: Gains from selling appreciated assets face taxation at both corporate and shareholder levels
The corporation files IRS Form 1120 annually to report income and calculate tax liability.
For instance, the business structure offers limited liability protection, ensuring that the personal assets of shareholders remain separate and protected from potential business liabilities. Understanding these operational and legal intricacies of a C corporation is key for entrepreneurs and startup founders considering this business entity.
Of course, considering your specific business needs and using a platform like Mosey after incorporation can help streamline the countless compliance tasks and ensure that you’re on the right track. Food for thought.
C Corporation Advantages and Disadvantages
Choosing a business entity is no small decision. It impacts how you pay taxes, raise capital, and even the degree to which your personal assets are protected. So, with that in mind, here are the advantages and disadvantages of C corps:
Corporation Advantages
Some of the benefits of a C corporation include:
- Limited Liability Protection: One of the standout advantages of a C corp is the limited liability protection it offers to its shareholders. Their personal assets remain separate and are typically shielded from business debts and lawsuits.
- Unlimited Number of Shareholders: A C corp can have an unlimited number of shareholders, offering ample opportunities to raise capital.
- Separate Legal Entity: As a separate entity, a C corp has its own legal rights. It can enter contracts, acquire assets, and sue or be sued independently of its owners.
- Stock Issuance: With the ability to issue multiple classes of shares, including preferred stock, a C corp can attract a variety of investors and offer different ownership and voting rights.
- Perpetual Existence: C corps continue to exist even if ownership changes or shareholders pass away.
Disadvantages
That said, a C corporation can also have certain downsides or limitations, such as the following:
- Double Taxation: Once again, the most frequently cited drawback of a C corp is double taxation. The corporation pays taxes on its business income at the corporate level. Later, shareholders pay taxes on dividends at their personal tax rates.
- Complexity and Cost: Establishing and maintaining a C corp can be more complex and costly. This includes filing fees for articles of incorporation, potential state fees like annual franchise tax, and the requirement for annual reports.
- Regulatory Requirements: C corps generally face more stringent regulatory requirements, such as adhering to specific state laws, maintaining corporate formalities, and having directors and shareholders meet regularly.
How Is a C Corp Different From an LLC?
C corporations and limited liability companies (LLCs) both have their uses, but there are a few key differences between the two.
These key differences include the following:
- Taxation: C corps undergo double taxation, whereas LLCs benefit from pass-through taxation, taxing owners just once on their personal returns.
- Structure: C corps maintain a formal structure with a board of directors and officers, whereas LLCs operate with more flexibility through an operating agreement without a required board.
- Stock: C corps can issue stock to attract investors, a feature not available to LLCs.
- Regulations: C corps face more extensive state and federal regulations compared to the simpler regulatory environment for LLCs.
Choosing between the two involves considering tax implications, operational flexibility, and growth strategies.
Is a C Corp Better Than an S Corp?
When you incorporate your business, you may have the option to form either a C corporation or an S corporation. Both C corps and S corps fall under the category of corporations, but they have distinct differences:
- Taxation: The most notable difference is in tax treatment. S corps are pass-through entities, much like LLCs.
- Shareholder Limitations: While a C corp can have unlimited shareholders, an S corp is limited to 100 shareholders, and they must be US citizens or residents.
- Stock Classes: A C corp can have multiple classes of stock, while S corps can only have one class of stock.
- Eligibility: Not all businesses qualify for S corp status. The IRS has specific requirements concerning shareholders, stock classes, and profit and loss allocation.
When to Choose a C Corporation for Your Business
C corporations work best for specific business scenarios:
Choose a C Corp When:
- Seeking venture capital (most funds require C corp structure)
- Planning an IPO or going public
- Need for foreign investors or other companies as shareholders
- Retaining most profits for growth rather than distributing to owners
- Want to issue preferred stock or multiple classes of shares
Choose an LLC or S Corp When:
- Distributing most profits to owners annually
- Expecting early-stage losses you want to deduct personally
- Keeping ownership simple without outside investors
- Want minimal corporate formalities and administrative requirements
Delaware corporations dominate among venture-backed companies due to well-established corporate law. The certificate of incorporation determines your initial structure, but you can change tax classification later as your needs evolve.
Take the 3-minute quiz!
Test your compliance strategy with this free download. You’ll see whether your processes are coordinated or chaotic.
How Do You Form a C Corp in Your State?
You want to begin your C corp journey by choosing and registering a distinctive business name through your state’s Secretary of State, then proceed to draft and submit the articles of incorporation. You’ll also want to identify and assign a dependable registered agent to handle official correspondences and formulate thorough corporate bylaws to direct internal operations.
Then, you’ll want to secure an employer identification number (EIN) from the IRS for tax-related matters and distribute stock to your initial shareholders. Complete the process by applying for all necessary business licenses and permits, ensuring your C corporation stays in compliance with all local and state requirements.
Compliance Tools for Your C Corporation
Navigating the complexities of C corporation compliance across multiple states can be a daunting task. Mosey is here to streamline the process, keeping all of your compliance needs in one place.
From ensuring you meet all state-specific requirements to helping you maintain ongoing payroll compliance, we’re here to help every step of the way. Book a free consultation with Mosey and start your journey toward hassle-free compliance today.
FAQ: What Is a C Corp?
What is better, an LLC or C corp?
Neither LLC nor C corp is universally better—the right choice depends on your business goals. LLCs offer pass-through taxation and simpler administration, while C corporations provide better access to venture capital and allow unlimited shareholders.
What is the meaning of C corp?
A C corp is a tax classification that treats a company as a separate taxable entity from its owners. The “C” refers to Subchapter C of the Internal Revenue Code, where corporations pay the 21% corporate tax rate and shareholders pay personal income tax on dividends.
What are the disadvantages of a C corporation?
The main disadvantages of a C corporation include double taxation on profits, higher administrative costs, strict corporate formalities, and losses that stay trapped at the corporate level. C corps also face more regulatory oversight and must maintain financial statements and directors and shareholders.
Is my LLC an S or C corp?
Your LLC is neither an S corp nor C corp by default—LLCs are legal entities that use pass-through taxation unless you file forms with the Internal Revenue Service. You can elect to have your LLC taxed as a C corporation, but most LLCs maintain their default pass-through status similar to partnerships.
