If you’re starting a new business (or reorganizing an old one), you have a few options to choose from. For example, you could form a Limited Liability Company (or LLC). LLCs are often a great choice for startups because they’re easy to start, simple to administer, and you can choose how you want it to be taxed — usually as a pass-through entity (so the company’s profits and losses pass right through to its owners). You could make a Subchapter S Corporation (or “S Corp”). An S Corp is another type of pass-through entity with tax benefits for owners who double as employees. It’s harder to start and trickier to administer than a LLC, but the tax benefits can be significant (if the company is profitable enough). For more on choice of entities, check out our sophisticated business entity selector tool. One commonly overlooked entity is, ironically, one of the oldest and most common business entities still in use across the country today. That entity is the Subchapter C Corporation (or “C Corp”), and it may just be the right choice for you.
What is a C Corporation?
A C Corp is what you might think of as a traditional corporation. While a LLC is owned by Members and a partnership owned by partners, a C Corp is owned by shareholders. Unlike most other business entities, a C Corp is a distinctly taxable entity. When a C Corp has income, the corporation pays federal (and, in the majority of cases, state) tax on that income. The money then belongs to the corporation until it decides to distribute that money to its shareholders in the form of a dividend — at which point, the shareholders themselves pay taxes on those dividends at the shareholders’ personal tax rates. This is commonly known as “double taxation” because the money is taxed twice before it reaches the shareholders’ pockets. By contrast, pass-through entities (S Corps, partnerships, and most LLCs) only have a single layer of taxation: when the company receives income, it passes directly through to the owners and is taxed only at the owners’ personal rates.
Why Choose a C Corp?
Double taxation seems like a pretty good reason to avoid a C Corp, right? You wouldn’t be wrong for thinking that, and, for the last few decades, businesses new and old have shifted away from C Corps when possible. However, there are a few things a C Corp can do that other business entities can’t.
For example, a C Corporation provides its shareholders with limited liability, but it also allows for multiple classes of stock with different rights to voting, distributions, redemptions, and more. S Corps are limited to only one class of stock. While LLCs can be customized to look like a C Corp, the process of adding and removing LLC members is usually a lengthy ordeal and can require modification of the Operating Agreement. Shares of a C Corporation are, by comparison, much easier to buy, sell, or swap. Since S Corps are limited to one class of stock and no more than 100 owners, a C Corp is often the best choice for any company looking to have a lot of owners with varying ownership rights.
Furthermore, a C Corp can have foreign owners (a S Corp cannot), and C Corps are generally favored by venture capitalists (VC’s) and investors (over LLC’s).
What About the Taxes?
While there’s no denying that double taxation can sting, especially if the owners are paying low marginal rates, recent developments have taken much of the sting out of double taxation.
First, Congress enacted several changes to the tax code in late 2017. One such change reduced the top marginal rate for corporate taxes (for C Corps) from 35% to 21%. This means that only 21% comes off the top when a C Corp receives that money, reduced further by any deductions to which the C Corp might also be entitled. From there, the C Corp can choose to give a shareholder dividend or reinvest that money in the company. In a way, this can result in a tax savings. If the company were a pass-through entity (like an S Corp or most LLCs) and wanted to reinvest its income into growing the company, that income would first be taxed at the owners’ personal rates — in some cases, as high as 35%. Therefore, C Corps have a potential tax advantage when it comes to reinvestment of income, if that is a strategy of your business.
Likewise, a C Corp can time the issuance of dividends to its shareholders to spread out the dividend income over different tax years (this is unavailable to a pass-through entity). Because of progressive tax rates and other considerations (such as a shareholder’s unrelated losses or other deductions in later years), this could result in shareholders paying less in taxes on their dividends than if they owned a pass-through entity and had to recognize all of the business income in the year it’s received.
C Corps vs LLC’s Taxed as C Corps
One of the biggest benefits of a LLC is the ability to choose how it’s taxed. You can elect to have your LLC taxed as a C Corp, with all the double taxation that comes with it. However, this is one case where the mimicry of a LLC falls short of the genuine article.
First, a LLC taxed as a C Corp is still unwieldy if you’re looking to have many owners or if the owners plan to frequently buy and sell their interests — or if the LLC wants to sell more ownership interest to raise money. By contrast, a C Corp allows for all of these activities in a streamlined fashion.
Moreover, shareholders of a C Corp enjoy certain tax benefits that members of a LLC — even a LLC taxed as a C Corp — don’t. For example, if you were to buy shares of a C Corp directly from the corporation in exchange for cash or property and, immediately after buying your shares, the corporation was worth $50 million or less, your shares would be considered “Qualified Small Business Stock”. If you turn around and sell those shares after 5 or more years of owning them, you may be entitled to exempt 50% of the gain from that sale — saving you considerable amounts of money. Alternatively, if you sell those shares at a loss, you may be able to treat that as an ordinary loss and use it to offset ordinary income — including, for example, wages and dividends.
Is a C Corporation Right For Me?
As is usually the case, the answer to this question is, “it depends”. Everyone’s short- and long-term business needs and goals are different. Here at Law 4 Small Business, we’re happy to sit down with you and go over your unique business plans. We often work collaboratively with our clients and their accountants to structure their business in a way that maximizes their tax savings and balances immediate needs with long-term growth potential. If you’re considering starting or reorganizing a business, give us a call today to see how we can help!