A C corporation (C corp) is a type of business structure that’s owned by shareholders and is governed by bylaws that are approved by its shareholders.
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A common alternative to a limited liability partnership (LLC) or an S corp, small business owners usually don’t pick C corps as their first choice. This is because C corps are subject to double taxation, typically have higher fees, and are generally more complicated. (We’ll get into the details of those complications below.)
However, for many companies, the C corp can be an appealing option because it allows people to take stock in exchange for an ownership stake. Startups typically form C corps, along with other companies that need to raise capital, plan to go public, or eventually get sold. Businesses that are looking to obtain outside investor financing might start out as an LLC but convert to a C corp when it’s time to obtain outside investments. On the flip side, a business can start out as a C corporation, and later elect to become an S corporation—which would change its tax structure to a pass-through tax structure.
Since C corps offer the most liability protection for their shareholders, they are also best for higher-risk businesses.
What are the benefits of a C corporation?
This particular business structure has several advantages. Here are the big ones:
- It is easier for investors to purchase and sell stock through a C corp structure than through other types of business entities, such as LLCs or S corps.
- C corps can offer stock in an initial public offering (IPO).
- C corps provide tax benefits to shareholders who purchase the stock directly from the company under IRS Section 1202, which covers Qualified Small Business Stock.
- The entity is completely separate from its owners with regards to corporate taxes, which do not require investors to receive, report, and pay taxes on their share of the profits of the company.
- C corps may claim deductions for fringe benefits, such as health insurance, long-term care, and disability insurance premiums—as long as the owner offers the same benefits to their employees.
- Net operating losses can be carried forward to offset future taxable income.
What are the drawbacks of a C corp?
Like everything, there are a few drawbacks to consider. Here are the ones we think stand out:
- The greatest drawback of a C corp is double taxation—since C corps pay taxes at the corporate level and any dividends distributed to shareholders are also taxed. That said, in 2017 the Tax Cuts and Jobs Act (TCJA) reduced the corporate tax rate to 21% so it’s not as big a drawback these days.
- C corps are considered more complicated than other entities because they require more paperwork. They are also required to elect a board of directors to represent their interests and make strategic decisions for the company; annual meetings that include the board, directors and shareholders must take place and meeting minutes must be properly recorded.
- Owners working in the business do not have the option to receive cash compensation in forms other than through a W-2.
How do I pay myself from a C corp?
There is generally one way to pay yourself from your C corp: as an employee. More specifically, if you’re involved in the day-to-day operations of running your C corp, then you’re considered a W-2 employee. Therefore, you will receive compensation via a W-2 that will also be subject to payroll taxes.
If you are an employee and an owner of the C corp, you will also receive dividends as a return of the profits to the shareholders.
How are C corps and their owners taxed?
C corps are subject to double taxation, which means the company will pay taxes on its profits and if some or all of those profits are distributed as a dividend to the shareholders, the shareholders will pay taxes on those dividend payments.
The company pays corporate income taxes on its taxable profit, which is what’s left after subtracting the business’s costs and expenses from its revenue. The federal corporate tax rate is currently a flat 21 percent.
Shareholders pay capital gains tax on dividends distributed to them throughout the year per the discretion of the board of directors.
At tax time, C corps complete the following two forms:
- IRS Form 1120: U.S. Corporation Income Tax Return is used to report the C corp’s gross income, tax deductions, and taxable profit
- Form 1099-DIV is provided to each shareholder, reporting the amount of profit that was distributed to them
There are two types of dividends: qualified and nonqualified.
Nonqualified dividends are dividend payments that don’t meet the qualified dividends requirements and don’t receive special tax treatment. There are some types of dividend payments that are automatically nonqualified including:
- Capital gains distributions
- Dividends on bank deposits
- Dividends from an Employee Stock Ownership Plan
- Dividends paid from a tax-exempt organization, master limited partnership, or real estate investment trusts
Qualified dividends have a lower tax rate but need to meet several requirements.
First, they must be paid out to shareholders from a US corporation or qualifying foreign corporation.
Second, a shareholder must hold the stock for at least 60 days out of a 121-day “holding period,” which begins 60 days before the “ex-dividend date.” If you’re a shareholder, you’ll need to own the stock by this date to receive a dividend payment.
Luckily, shareholders don’t need to worry about figuring out if a dividend is qualified or nonqualified. Form 1099-DIV will list the amount and type of dividend payment.
Shareholders report the amount using Form 1099-DIV on their personal tax returns. Generally, most corporate dividend payments are qualified dividends and taxed at a rate of 0%, 15%, or 20%, depending on the shareholder’s filing status and taxable income.
What’s the difference between a C corp and a single-member LLC?
The biggest difference between a C corp and an LLC is how they’re taxed. An LLC is a pass-through entity, which means all the business profits are passed on to the owner’s tax return.
If an LLC makes $100,000 in profit, for example, the owners of the LLC will pay taxes on their share of the $100,000 on their personal return, regardless if those profits were distributed to the owners or not. LLC owners are responsible for paying income tax on the profits of the company—and active LLC owners will also pay self-employment tax, which starts at 15.3%.
On the other hand, if a C corp makes $100,000 in profit, the owner’s of the business would only pay corporate taxes on the profits at a rate of 21%. The owner’s would then pay income tax on the dividend payments—usually at a lower rate—and wouldn’t have to pay self-employment tax on the dividend payments.
Here’s a tax breakdown between C corps and LLCs:
LLC vs. C corp: Tax the business pays
|Corporate tax (21%)||$0||$21,000|
LLC vs. C corp: Tax the owner pays
|Amount distributed to owner||$50,000||$50,000|
|Income reported on owner’s personal return||$100,000||$50,000|
|Income tax (single filer with standard deduction)||$13,620||$5,625*|
*Based on a qualified dividend taxed at 15% tax rate
In this example, the total taxes paid for a single-member LLC are $27,750, while the total taxes paid for a C corp are $26,625.
There are other important differences between the two business structures.
- Can’t claim the pass-through deduction. C corps aren’t pass-through entities, which means they aren’t eligible for the pass-through deduction. LLCs are eligible for the pass-through deduction.
- Consider the owner an employee. C corps can pay its owners as employees, while LLCs can’t.
- Can issue shares. This attracts investors and enables the business to go public, or IPO. While LLCs can have multiple owners, the percentage of ownership is outlined in the operating agreement.
- Have meeting requirements. C corps are required to hold annual meetings and record meeting minutes, while LLCs are not.
What’s the difference between an S corp and a C corp?
The main difference between an S corp and a C corp also comes down to taxation. Like an LLC, S corps are pass-through entities, but are not required to pay self-employment taxes.
S corp owners are required to pay themselves a “reasonable compensation” as an employee of the company and must pay FICA payroll taxes. The owner’s salary and employer payroll taxes are considered deductible expenses for the company.
C corp owners can also be paid as an employee of the company and are required to be treated as an employee if they’re involved in the daily operations of the business.
Finally, S corps don’t pay corporate taxes on their profits, while C corps do.
Here’s a deeper look at S corps vs. C corps:
S corp vs. C corp: Tax the business pays
|S corp||C corp|
|Business profit (pre-salary)||$100,000||$100,000|
|Payroll taxes: 7.65% (FICA) + 0.06% (FUTA)||$4,259||$0|
|Corporate tax: 21%||$0||$21,000|
S corp vs. C corp: Tax the owner pays
|S corp||C corp|
|Business profit (pre-salary)||$100,000||$100,000|
|Taxable profit (post-salary)||$50,000||$100,000|
|FICA payroll taxes: 7.65%||$3,825||$0|
|Amount distributed to owner||$0||$50,000|
|Income reported on owner’s personal return||$100,000*||$50,000|
|Income tax (single filer with standard deduction)||$15,246||$5,625**|
* Gross wages plus taxable profits
**Based on a qualified dividend taxed at 15% tax rate
The S corp pays $23,330 total in taxes, while the C corp pays $26,625.
S corps and C corps have a few more differences.
- Can claim the pass-through deduction. S corps are pass-through entities and therefore are eligible for the qualified business income deduction, while C corps aren’t.
- Are limited in size. C corps can have unlimited owners, while S corps are limited to 100 owners.
- Have ownership limitations. Foreign citizens and other businesses can own C corps, while an S corp must be owned by US individuals.
- Are limited in stock type. C corps can issue multiple classes of stock, while S corps can only issue one kind of stock.
And that’s (mostly) everything you need to know about C corporations. Now you can decide if a C corp is the right entity type for you as you work toward starting your first business.
This article was originally published on November 1, 2019.