As a small business incorporates, it instantly becomes a C corporation, which is also known as a regular corporation. Basically, the main characteristic of the corporation is that it is legally seen as an individual entity, which is quite different from its owners, who happen to be shareholders. What this implies is that if the corporation gets sued, shareholders are only liable to the level of their investments in the corporation.
Here, their personal assets would not be affected, as would have been the case if the business was a partnership or a sole proprietorship. If the corporation incurs a debt, the debt is also seen as the corporation’s responsibility. Thus, immediately the business is incorporated, shareholders are safeguarded by the corporate veil of limited liability.
Since the corporation is separate from its owners, it is seen as an individual taxpayer by the Internal Revenue Service (IRS). Because of this, the corporation gets subjected to double taxation, which implies that the profits are taxed once on the corporate level and a second time when they are distributed as dividends to the shareholders.
In case a business is eligible, it may opt for an S corporation status upon incorporating to avoid the disadvantages that come with a C corporation.
How Corporation Works
Corporations pay corporate taxes on earnings before it distributes the remaining amounts to the shareholders in the form of dividends. Thereafter individual shareholders are subject to personal income taxes on the dividends they get. With a C corporation, you have the ability to reinvest profits in the company at a lower corporate tax rate, which is an advantage.
C corporations are expected to hold at least one meeting each year for shareholders and directors. Minutes must be maintained in order to display transparency in business operations. A C corporation is required to keep voting records of the company’s directors as well as a list of the owner’s names and ownership percentages. The business must also have company bylaws on the premises of the primary business location, and file annual reports, financial disclosure reports, and financial statements.
Difference Between S Corporation and C Corporation
Small business owners who want to know the difference between S corporations vs. C corporation, should note that the decision mostly boils down to how they want the corporation to be treated for federal income tax purposes.
C corporations are separately taxable entities, which files a corporate tax return (Form 1120) and pay taxes at the corporate level. They are also susceptible to possible double taxation of corporate income is distributed to business owners as dividends, which are considered personal taxable income. Corporate income tax is first paid at the corporate level and again at the individual level on dividends.
These are pass-through taxation entities who file an informational federal return (Form 11205), even though no income tax is paid at the corporate level. Here, the profits/losses of the business are instead channeled to the business and reported on the owners’ personal tax returns. For S corporations, tax due is paid at the individual level by the owners.
Personal income taxes
For both C corporations and S corporations, personal income tax is due both on any salary which is drawn from the corporation and from any dividends received from the corporation.
Even though state corporation laws do not make any distinction between S corporations and C corporations, the Internal Revenue Code does place several restrictions on who can be shareholders in a bid for the corporation to qualify to be an S corporation.
S corporation is restricted to no more than 100 shareholders, and shareholders must be US citizens/residents, while a C corporation on the other hand has no restrictions on ownership.
A C corporation, can not own S corporations, other S corporations (with some exceptions), LLCs, partnerships, or many trusts.
S corporations can only have one class of stock (disregarding voting rights), while C corporations on the other hand, can have multiple classes.
Advantages of C Corporation
An unlimited number of shareholders: No limit on the number of shareholders a corporation taxed under Subchapter C can have.
No restrictions on ownership: Anyone is at liberty to own shares, including business entities and non-US. citizens.
No restrictions on classes: A C corporation can issue more than one class of stock, which includes stock with preferences to dividends and distributions.
Lower maximum tax rate: The 2017 tax reform act brought down the corporate tax rate to a flat 21% and eliminated the alternative minimum tax.
More options for raising capital: A C corporation can easily obtain equity financing since Subchapter C of the tax code does not impose the same restrictions on ownership as Subchapter S.
Disadvantages of C Corporation
The main disadvantage of a C corporation is the tax payment paid on its earnings and then shareholders pay tax on dividends, which implies the corporation’s earnings are taxed twice.
A corporation is more complex to run more than an LLC. Corporation laws need more formalities in how a corporation is managed.
How to Become a C Corporation
You form a corporation by filing a document, generally known as Articles of Incorporation (sometimes known as Certificate of Incorporation) with the state, and pay filing fees.
First, you must choose a name (after ascertaining that it is available to you) and choose your corporation’s registered agent. Note that the name of the corporation and the registered agent has to be included in the Articles of Incorporation.
Once the Incorporation process is completed, there are other requirements to complete, like adopting bylaws, holding an initial meeting of directors and shareholders, and issuing shares of stock to owners. Your corporation gets taxed under Subchapter C except you qualify for, and elect to be taxed under Subchapter S.