Before I dive into discussing the pros and cons of a C-Corp, I briefly want to touch on some other things relevant to you as a small business owner.
The threat of it hangs in the air like a Midwest thunderstorm. And as you anticipate it, you don’t have to wait idly for it to hammer your business. There are recession-proof moves you can make (choosing the right business entity structure being among them) to help your business.
Even Congress is trying to make an impact. The passing of the Inflation Reduction Act could actually mean good things for your business.
Now, last week, I gave you an overview of the various business entity types. So this week, I want to start diving into the most popular one – the C-Corp – to help you determine which one is right for your business.
Let’s dive in, shall we?
C-Corporation: Pros and Cons
“The secret of getting ahead is getting started.” – Mark Twain
It’s only natural that you might want to pick the corporate structure of your company based on the one you’ve heard the most about: C-Corporations. The C-Corp is a prevalent corporate structure it’s true, but what are its pluses and minuses?
This decision is huge for your company, so make sure the C-Corp is right for you. Here’s what to know.
The C-Corporation – named after the subchapter of the Internal Revenue Code that covers its tax designation – is a legally formed separate entity that insulates its owners/shareholders from its debts, among other benefits. It can borrow money, sell stock and engage in investment contracts. For federal income tax purposes, a C-Corp is recognized as a separate taxpaying entity.
Generally, a corporation conducts business, realizes net income or loss, pays taxes, and distributes profits to shareholders. The profit is taxed to the corporation – the current corporate rate is 21%, though that might go up – and then the shareholders pay income tax when the profit is distributed as dividends.
And you’re right: This can create a double tax. The corporation also doesn’t get a tax deduction when it distributes dividends to shareholders, and shareholders can’t deduct any loss from the corporation.
You form a C-Corp by, among other tasks, filing with your State. These corporations operate according to state law; rules vary from State to State. Your best bet is to set up the corporation in the State where your operation is based.
C-Corps may not be best for all small business owners (see below) but if you’ve been in business long enough to want flexibility and the chance to responsibly raise capital, C might be the way to go. (A surprising number of C-Corps also have fewer than 500 employees.) Here are some advantages…
Limited Personal Liability. This is one of the biggest draws. Forming a C-Corp turns your business into a legal entity separate from you and your personal assets – meaning they can’t be seized in a lawsuit that relates to your business or by creditors looking to square a business debt. In short, no shareholder, officer, or director is liable for debts of the corporation unless corporate law is breached or a personal guarantee given.
(Judges have been known to rule that a C-Corp structure just masks shady business doings, but this is rare and unlikely to apply to you and your business.)
Investors. A C-Corporation can sell stock or shares, either common or preferred, and there’s no limit to the number of shareholders (see below); you can also have international shareholders. C-Corps can go public – the glorious IPOs – and offer employees a stock option plan.
Investors and venture capitalists (there’s no limit to the latter you can approach, either) tend to view C-Corps as more reliable and ultimately more profitable companies. Lenders and other types of financiers tend to as well.
Flexibility on taxes. C-Corps have more tax options than sole proprietorships, LLCs, LLPs, and S-Corps do. Yes, C-Corp business profits can become subject to double taxation, as we mentioned. But there are ways to trim this burden: Shareholders can be given a salary, for instance, and the corporation can write this money off as a business expense. Portions of startup costs are also deductible, and you can divide profits and losses between the business and the owners to create an overall lower tax rate.
Legal precedents. Corporate law is well-established, and C-Corps have been around a while and been the subject of many decisions. Should you find yourself in court regarding your company, your outcomes will likely be much less surprising.
No decision is one-sided in business, and picking a C-Corp has its potential wrinkles.
Higher costs. The double taxation we covered (you also can’t write off business losses on your personal return). You pay various state and federal filing fees, plus your tax situation can be more complicated, as we said. Fees can be repeated, and tax filing is more involved. This means you need additional skilled professionals, such as lawyers, to help you.
More paperwork. You have to file a number of documents, including Articles of Incorporation, corporate bylaws, corporate minutes, certificates of good standing, and, when the C-Corp gets enough shareholders, registration with the U.S. Securities and Exchange Commission. Again, you’ll have to pay for expert advisors to handle all this.
More structure. This isn’t a business entity you run off your dining room table. For one, you have to hold formal shareholder meetings every year and keep detailed records of those meetings.
Even with these downsides, it’s easy to see why C-Corps are popular.
Choosing a business entity is an important decision and one that should not be done without examining all the possibilities.
Hang on! Don’t jump into a C-Corp without considering the pros and cons of other entities. I will cover other entity structures in coming weeks. Stay tuned…
BE THE ROAR not the echo®