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C-Corporation is one of the oldest business entities that's available for business owners.
It is very commonly used by both big and small companies.
In this guide, you'll learn a whole lot about C-corporation that is not available elsewhere. This isn't your average "What is C-corp" type of guide. So, brace yourselves.
LLC makes it super easy for business owners to grow their business and protect their personal assets at the same time.
You'll learn the specific situations where C-corp is best suited. By the end of this guide, you will learn enough to make a truly informed decision of whether to go ahead with C-corp or not.
C-Corporation or C-Corp is an independent legal entity that is separate from its owners and has a perpetual existence.
OK, that's the textbook definition. Let's understand what we mean by "separate from its owners" and "perpetual existence".
Separate from its owners:
C-corp is a completely separate legal and tax entity from the people who own it. So, from a legal and IRS' points of view, C-corp is an independent entity.
This separation gives the owners (or shareholders in this case) protection from personal liability. So, the shareholders are not "personally" responsible for the corporation's debts and obligations.
This separation is observed from both tax and legal point of view: Corporation is a separate legal entity as well as a tax entity.
This is not like most other entities. For example, Sole proprietorship is not a separate legal entity nor a tax entity. LLC is a separate legal entity, but not a separate tax entity(in most of the cases).
Coming to the second point, perpetual existence:
It means just like how it sounds. C-Corp continues to exist even if owners expire/leave the company. All the assets, debts and obligations belong to the corporation itself. Not its shareholders.
This makes it more comfortable for creditors and lendors to work with a C-corp.
OK, so these 2 are the defining features of a C-Corp.
Let's now understand things more in depth.
Ownership in a C-corp is given out by offering company's stock.
Ones who own this stock are the owners/shareholders of the corporation.
It can be owned by just about anyone: individuals, other corporations, trusts, foreign individuals.
There is no restriction on who can hold shares.
With these shares, you get economic and management rights over the corporation.
And unless it is specifically mentioned in the articles of incorporation, these shares can be easily transferred. You can buy and sell these shares freely.
That is one of the reasons why investors love C-corp.
Want more reasons? Let us see below.
People can take up different roles in a C-corp.
These roles come with different responsibilities: legal and operational.
And most often, these different roles make the corporation seem too complicated. People often think board of directors, president, officers, etc are possible only in super big companies.
That is not true. In a startup, all these roles can be taken up by even a single person. So, it is not limited to the "big guys".
Let us see what some of these roles mean:
C-Corp usually pays 3 types of taxes: Income tax, payroll tax and franchise tax.
They are paid to the federal government and state agencies.
All taxes are not paid the same way.
Depending on the state of incorporation, total assets, issued shares and how members are paid, tax treatments can vary.
Corporate income tax is paid at Federal and State levels separately. This is paid by the corporation, not by the shareholders.
Federal corporate tax is paid by all corporations at a corporate annual rate. Form 1120, US Corporation Income Tax Return is filed to report income, gains, losses, deductions, etc.
State corporate tax is paid only in certain states. It depends on where you are incorporated and where you are operational. For example, in order to attract businesses, states like Wyoming have zero state corporate tax.
Social Security tax, medicare taxes and unemployment insurance are commonly referred to as 'payroll taxes'. Corporations have to pay this when they have employees.
Half of this tax amount(except for Federal Unemployment Tax Act(FUTA) tax) is collected from the employee's paycheck. And the other half is contributed by the corporation.
Form 941, Employer's Quarterly Federal Tax Return is filed to report income taxes, Social Security tax, or Medicare tax withheld from employee's paychecks.
Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return is filed as well.
Most states charge an annual fee, often called as "franchise taxes", "renewal fees" or "annual registration fees". This could be fixed, or variable depending on the authorized shares and assets. States have different methods of calculating franchise taxes.
In addition to this franchise tax, almost all states have a small annual report fee to be paid while filing a mandatory annual report.
Also, excise taxes are typically imposed on manufacturers and retailers of goods and services. Not very common, however still important to many types of businesses.
For most corporations, taxes are paid as 4 quarterly instalments, instead of a one-time payment at the end of the year.
Whether it is income tax, payroll tax or franchise tax, everything is paid this way.
Only in a few cases, you don't have to split the tax into 4 instalments. That is, if your federal income tax is estimated to be less than $1000, you don't have to. Also, depending on the state you are incorporated in, franchise taxes have a minimum limit. If you fall below the limit, you don't have to split the total amount.
IRS and state agencies are pretty serious about quarterly payments.
They charge a penalty if you fail to pay an instalment or pay it late.
So, keep this in mind.
These are some of the most common tax rates applicable to a C-Corp.
Of course, some of these numbers will vary depending on your situation.
Take this only as an approximate figure.
Corporations owned by non-residents have to pay income tax and other taxes in the United States. If dividends are issued to a shareholder outside US, the corporation has to withhold 30% of the amount and pay to the IRS unless there is a tax treaty with the non-resident's country.
State-specific obligations vary a lot. To give you an idea, take a look at Delaware and Wyoming.
Coming to everybody's favourite topic:
How to pay yourself in a corporation?
There are 3 ways of taking money out of a corporation: Taking a salary, through dividends or selling stock.
Let us understand how each of it works.
As a founder/shareholder, taking a salary is almost always the best method of getting paid if you want to avoid double taxation.
Salaries and bonuses are tax deductibles in a corporation. Taking a salary is one of the most common ways, founders pay themselves.
This doesn't mean you take an exorbitantly large paycheck, though. There are checks and balances. And it shouldn't look like you are evading tax. Talk to your CPA about this.
The salary amount has to be on par with industry standards.
Once you receive the salary, you will have to pay personal income tax on it.
But, there's a problem if you have a lot of shareholders: you can't hire everyone as an employee.
In that case, you'll have to issue dividends to the shareholders. Or pay nothing until shareholders can sell their stock at a higher premium in the future.
When corporations pay dividends to shareholders, it is subject to double taxation.
At the corporate level, dividends are not tax deductibles. Therefore it is taxed at the corporate income tax rate, first.
Then, when the dividends are received by the shareholders, each of them will have to pay capital gains tax on it. That is the second tax.
Many corporations try to avoid this problem of double taxation by either not issuing dividends or by paying themselves salaries.
Most high-growth startups do not issue dividends to shareholders. For example, Amazon, Google and Facebook have not issued any dividends till date.
Their shareholders are invested for the long-term. They will get a payout if their shares are sold in the future.
That's the next point.
Investors are attracted to startups that offer a high return on their investment.
So, when these investors invest their capital, they are not looking for small gains through dividends. They are looking for big wins.
They usually get multiples of their investment returned when the startup gets acquired or have an IPO.
That is why you don't see a lot of tech startups offering dividends to their investors. Instead, they re-invest that amount and grow faster.
Corporations are considered more expensive to incorporate and to maintain as compared to other entities.
It's not a deal-breaker for most founders, though. Let's see what the common costs are.
Of course, the costs vary according to how you structure your corporation.
Biden Administration proposed an increase in capital gains tax to 39.6% for individuals with incomes over $1 million. They also proposed an increase in corporate tax rate to 28% and elimination of several deductions.
C-corp is one of the best entities to hire employees.
Why? Because there are plenty of expenses and deductions allowed by IRS that incentivize you to hire people.
The incentives are so good that this is another reason for founders to be hired as employees.
Some of them are:
There are lots of case laws and precedents available for corporations, making it easier for business-friendly legal proceedings as well.
Hiring comes with a few responsibilities, though.
If a non resident-owned C-Corp has an employee living in the US, you would have to start paying payroll taxes. If you wish to avoid having to pay payroll taxes, you can hire independent contractors or freelancers. The law asks you to pay taxes if you have a 'dependent agent' in the US. How to establish 'dependence' is a slightly complicated area. It is best to speak with a lawyer regarding this.
If majority of your operations are in your home state, It is better to incorporate there.
If you incorporate elsewhere, but have most of the operations in your home-state, you will have to register your corporation in the home state. This is known as foreign qualification.
However, if you are a tech startup that is looking to expand your business across the nation, then it is better to incorporate in a state that has low state taxes even if your operations are in another state.
In this case, the savings you get from a low-tax state far outweigh the costs of foreign qualification.
And if you don't have operations in US, it is best to go for Delaware or Wyoming because of their low taxes and robust legal system.
It is also important to note that investors love Delaware. They often require startups to incorporate in Delaware because the their corporate law is very business-friendly. Also, the Court of Chancery in Delaware is very efficient and cases there are decided by judges experienced in this law, not juries.
If you don't have any employees or a physical office in the US, you could choose either Delaware or Wyoming to incorporate. It is because these two states are very business-friendly and have the best legal structure in place.
Here are the steps to incorporate your business:
Once your corporation is up and running, you'll come across situations where you may want to convert your business entity.
You may want to reduce your taxes. Or maybe you have an LLC and you're thinking about incorporating. Whatever your reason be, it is possible to make such conversions.
If you are still confused whether C-Corp is the right entity for you, that's fine.
Let's compare entities directly and drill down on their differences.
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