Business owners have plenty of options when it comes to selecting the most appropriate entity structure for their company. One popular choice is the C Corporation, or C Corp for short.
These entities are among the most common entity structures employed by businesses, particularly larger, more well-established businesses. A C Corporation is considered a separate entity from its owners, meaning that it is taxed separately from its owners, an approach that has both benefits and drawbacks.
From a non-tax perspective, C Corporations offer their owners liability protections and also ensure higher levels of business continuity. However, C Corporations do face a greater administrative burden than other entity structures, and as such they may not be the best choice for every business.
In this overview, we discuss the advantages and drawbacks of structuring an entity as a C Corporation. Through both a tax and non-tax lens, we explore the key considerations business owners need to bear in mind when evaluating whether a C Corporation is the most appropriate entity structure for their business.
This article is part of our series on entity selection. View our other articles here:
A C Corporation is a legal entity that exists distinct from the shareholders that own, manage, and control it. It is considered the default corporation structure by the IRS.
As separate legal entities, C Corporations are taxed separately from their owners, unlike flow-through entities such as Sole Proprietorships, LLCs or S Corporations. C Corporations are subject to double taxation, with the profits of the company taxed at both the corporate income tax level immediately and the personal level when cash or profits are paid to its owners.
C Corporations are popular for a range of reasons. One of the most important is the liability protections that C Corporations offer their owners. Another is the level of flexibility C Corporations allow: C Corps can have an unlimited number of owners and can create multiple classes of stock.
As we noted earlier, C Corporations are essentially taxed twice. The first layer of tax is on the C Corporation’s profits before distributions are made to shareholders.
This income is currently taxed at the 21% federal corporate income tax rate, plus the applicable state income tax rate. Depending on the state the C Corporation is located in, these state tax rates can range from 0% to 11.5%. State corporate income taxes are deductible expenses for federal corporate income taxes. Other credits and deductions the entity qualifies for may be used to offset these taxes.
Once these taxes have been paid, the C Corporation may choose to distribute remaining profits to its shareholders in the form of dividends. These individuals are liable for federal income taxes of 20% on this income plus a 3.8% Net Investment Income Tax (NITT). The NITT 3.8% only applies for taxpayers over certain income thresholds.
With the right tax strategy, it is possible for C Corporations to minimize this double taxation. Instead of distributing dividends to shareholders, a C Corporation may reinvest profits into acquisitions, expansion, capital improvement projects, retooling, and so on. Over time, the goal is that these reinvestments increase the value of the company, leading to a better outcome for shareholders while minimizing the timing of the double taxation.
Owners of stock in a C Corporation may be eligible to take the Qualified Small Business Stock Exclusion (QSBS), provided the C Corporation’s assets are valued at $50 million or less and several other conditions are met when the stock is issued. The QSBS exclusion offers favorable capital gains tax treatment, often unlocking millions of dollars of tax savings for investors in the event that the company is sold. If you qualify for this exemption, it is possible you could exclude up to $10,000,000 of capital gains from the sale of your stock.
C Corporations present a wide array of tax opportunities, many of which can be relatively complex. To determine the opportunities that may be available to your business, contact a trusted tax advisor today.
While there are a range of tax considerations that business owners should consider before forming a C Corporation, there are also many non-tax considerations that must be assessed. Below, we’ve summarized some of the most important considerations that business owners should keep in mind:
C Corporations are often a strong fit for both ambitious and well-established businesses. They offer strong liability protections and are a good match for businesses that rely on external investment, despite the additional costs involved in running a C Corporation.
Understanding the tax considerations that apply to a C Corporation can be complex and it’s always advisable to partner with an experienced tax advisor to identify whether a C Corporation is the most appropriate entity structure.
At Smith + Howard, we work with business owners representing a diverse range of companies from all industries and stages of maturity. Our experienced professionals are available to help business owners select the most appropriate entity structure for their business, balancing tax planning with operational concerns.
To learn more about how Smith + Howard can support your business, contact an advisor today.
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