Choosing the right business structure is a pivotal decision, and a C corporation is one option that comes with its own set of advantages and disadvantages. This structure can have a notable impact on how your business operates and its financial health.
Let’s break down the key benefits and drawbacks of operating as a C corporation.
Tax implications
A C corporation is treated as a separate legal entity, which is taxed separately from you as the principal owner. With a corporate tax rate currently set at 21%, this can be lower than the top individual tax rate of 37%.
However, one of the notable drawbacks of a C corporation is the potential for double taxation. Profits are taxed first at the corporate level, and then dividends distributed to shareholders are taxed again at the individual level. This structure can result in a higher overall tax burden compared to other business entities.
But, if most of the corporate earnings are tied to your role as an employee, the impact of double taxation may be reduced since the corporation can fully deduct any reasonable salary it pays you.
Since a C corporation is taxed as a separate entity, all income, credits, losses, and deductions are calculated at the corporate level to determine taxable income or loss. One potential downside for a new business is that losses are confined to the corporation and generally cannot be deducted by the owners. However, if you anticipate turning a profit in the first year, this might not be an issue.
Liability protection
One key advantage of a C corporation is the limited liability protection it provides. Shareholders are not personally responsible for the corporation’s debts or liabilities, meaning their personal assets are typically shielded if the business encounters legal troubles or bankruptcy.
Complying with requirements
To maintain a corporation’s status as a separate entity, it’s important to follow certain formalities as set by your state, including:
- Filing articles of incorporation
- Adopting bylaws
- Electing a board of directors
- Holding organizational meetings
- Keeping minutes of meetings
Adhering to these requirements and maintaining a solid capital structure will help protect you from unintentionally assuming personal liability for the corporation’s debts.
Fringe benefits
A C corporation can also offer fringe benefits and fund qualified pension plans with tax advantages. The corporation can deduct the costs of benefits like health insurance and group life insurance, within certain limits, without triggering negative tax consequences for you. Similarly, contributions to qualified pension plans are typically deductible by the corporation but are not taxed to you at the time of contribution.
Raising capital
A C corporation offers significant flexibility in raising capital from outside investors. It can issue multiple classes of stock, each with distinct rights and preferences, tailored to meet your needs and those of potential investors. Also, if you choose to raise capital through debt, the interest paid by the corporation is deductible.
The right fit
While a C corporation might be the right structure for your business now, you can opt to convert it to an S corporation if that better suits your needs. This change is typically tax-free, but any built-in gains on the corporate assets could be taxed if the assets are sold within 10 years of the change.
This is a high-level overview of the benefits and drawbacks of a C corporation. Contact your Smolin advisor with specific questions or to explore which business entity is best for you.