C-Corporation

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.

Definition

What is a C-Corporation?

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

Can anyone own a C-corp?

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.

For non-residents

C-corporation is one of the popular business entities chosen by non-residents. You or your business entity in your home country can be the shareholders of the C-corp. And you can easily incorporate a C-corp without even having to visit US.

Advantages

What's so special about a C-corp?

Raise capital

Because of the ability to issue various types of shares, you can raise external capital from angel investors, venture capitalists and other investors. This is not possible for LLCs, sole proprietorship and partnership. C-corp can also issue unlimited shares to unlimited number of people, making it the best entity for IPOs.

Limited liability

Shareholders are not personally liable for the corporation's debts and obligations. Personal assets are separate from corporate assets. Shareholders only stand to lose a maximum of how much they have invested. Nothing more.

Perpetual existence

Even if shareholders and the management exit the corporation, the corporation still exists. This brings more credibility to a C-corp. Creditors and lendors feel more reliable working with an entity that has perpetual existence.

Lower corporate tax

LLC, sole proprietorship and S-Corp are taxed at the individual level. Unlike them, C-Corp is taxed at the corporate level. This corporate tax rate is often much lower than individual tax rates.

Plenty of deductions

IRS allows various types of expenses and deductions for a C-Corp. These help in saving tax and getting some cool benefits. Some of them include reimbursement for employee fringe benefits, health insurance premiums, dental/eye care, salaries and bonuses, rents. Since there are several employee-related benefits, many founders choose to be hired as employees in a corporation.

Better legal support

C-Corp is one of the oldest business entities. So, they have a lot of precedents and case laws, making it easier in the courts.

Disadvantages

When is C-corp not right for me?

More paperwork

Compared to other entities, C-corp has more paperwork and regulations at the federal, state and local levels. This includes drafting corporate bylaws, issuing annual reports, electing board of directors, conducting annual meetings, etc. However, the complexity is often exaggerated. Most founders do not find it to be a huge disadvantage.

Double taxation

When a corporation pays dividends to its shareholders, that amount is taxed twice: first at the corporate level, second at an individual level. This can be avoided if the shareholders are hired as employees. Moreover, most high-growth startups usually do not offer dividends in the early stages. Think: Google, Amazon and Facebook haven't paid dividends to shareholders till date.

No deduction of corporate losses

If your corporation is making losses, you cannot deduct these losses from your personal income tax liability. Because a corporation does not pass income to its owners. It pays tax at the corporate level itself. It is similar to the old adage: "What happens in a C-corp, stays in a C-corp" ;)

Roles in a corporation

Who runs a corporation?

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:

Shareholders

These are the actual owners of a C-corp. They provide the initial and ongoing capital. Each of them owns a portion of the ownership known as a share of stock. Depending on the type of stock they hold, they have different rights and have different priorities when it comes to liquidation.

There is no limit to the number of shareholders you can have in a C-Corp. Most of the time, founders are the only shareholders in the initial days. There can also be shareholders who are not involved in the day-to-day operations.

Directors

Directors are elected by the shareholders to be their representatives and to protect their interests. A corporation is governed by its board of directors. They have a fiduciary duty to act in the best interests of the corporation.

When the corporation is small, directors may be involved in daily operations. But as it grows, directors may only oversee the corporate affairs. They delegate management work to corporate officers.

Officers

Officers are the executors: ones who get things done. Their roles are defined by corporate bylaws, articles of incorporation and statues. Common roles of officers are president, vice presidents, treasurer and secretary.

President acts as the primary officer and is the CEO of the company. Vice presidents are second in command and make decisions in the president's absence. Treasurer keeps track of the corporate's finances, whereas secretary keeps track of corporate records and takes minutes at corporate meetings.

Taxes

What are my tax obligations?

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.

The 3 most common taxes are:

Income tax

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.

Payroll 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.

Franchise & Excise taxe

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.

Note

Take the time to understand how each state calculates their franchise taxes. If you don't understand how your chosen state calculates it, you could end up with a tax amount in hundreds of thousands.

When to pay taxes?

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.

Tax rates

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.

21%

Federal corporate income tax rate

0-13.3%

State corporate income tax

6.2%

Employer portion for social security tax

1.45%

Employer portion for medicare tax

23.8%

Individual income tax on shareholder's dividends

Total FUTA tax including state credit

For non-residents

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.

Delaware

State corporate income tax rate: 8.7% of federal taxable income

Wyoming

There is no state corporate income tax.
Annual Report License tax: Greater of $50 or $0.002 on every dollar of company's assets located in Wyoming.

Pay Yourself

How do I pay myself from a C-corp?

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.

Taking a salary

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.

Earning dividends

When corporations pay dividends to shareholders, it is subject to double taxation.

How?

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.

Selling stock

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.

Costs

How much does a corporation cost?

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.

One time

Incorporation fee for the State

~$100

Reserve business name

$75

Annually

Registered agent costs

$100 - $300

State annual report fees

$50 - $75

Quarterly

Federal Income tax

21 - 28%

State Income tax

0 - 13.3%

Payroll tax - employer contribution

7 - 10%

State franchise tax

$175 - $250,000

Personal capital gains tax

0 - 20%

Service charges

Lawyer

$100 - $500/hour

CPA

$100 - $500/hour

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.

Hiring

Can I hire employees in a corporation?

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:

Health insurance premiums
Dental and eye care
Compensation of officers
Salaries and bonuses
Pension
Rents
Charity donations

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.

Corporation has to withhold tax from the employee's wages for Social Security, Medicare and unemployment insurance, deposit it with the IRS and state agencies.
Corporation has to file Form W-2 for each employee with the IRS.
Depending on the state you're in, state and local authorities have to be notified about new hires.

For non-residents

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.

State of Formation

Which state should I form my C-corp in?

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.

For various businesses

If you're looking at venture funding and high growth, you may want to select a state like Delaware that's business friendly.

If you are offering IT services, you would most likely be working from home or a co-working space. In that case, it is better to incorporate in the state where you reside. There isn't any significant advantage in an out-of-state incorporation for you.

The state where most of your employees are located is the ideal place to incorporate. There may not be any significant advantage in an out-of-state incorporation for you.

For a high growth SaaS company, you may want to look at Delaware or Wyoming because of how investor-friendly and business-friendly those states are. Almost all VCs are comfortable with Delaware law. They may eventually ask you to incorporate in Delaware.

For non-residents

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.

How to incorporate?

What if I wanna convert to another entity?

Here are the steps to incorporate your business:

01Choose a state of incorporation
02Pick a name and reserve it with your state (optional)
03Nominate a registered agent
04Draft and file articles of incorporation
05Appoint directors of the corporation.
06Issue stock certificates to initial stakeholders
07File SS-4 or online to get EIN
08Draft corporate bylaws
09Conduct the first board of directors meeting

Converting C-Corp

Is C-corp the best entity for me?

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.

Why should you convert?

S-Corp is a pass through entity which does not have double taxation. Shareholders of an S-Corp pay income taxes at a personal level. So, for most small corporations with 2 or 3 shareholders, opting for S-Corp will prevent double taxation and result in lower overall taxes.

How to?

If the C-Corp is eligible, file Form 2553, Election By a Small Business Corporation.

Why should you convert?

S-Corp can have only a maximum of 100 shareholders, all of whom have to be US citizens or permanent residents. If you wish to take foreign capital or wish to go for an IPO, C-Corp would be a better fit.

How to?

Along with a consent letter from the majority (>50%) of the shareholders, you may file a written statement with an IRS service center.

Why should you convert?

Happens very rarely. This may be done by smaller businesses who wish to have pass-through income and avoid double taxation.

How to?

C-Corp is considered completely liquidated. Capital gains resulting from it will be subject to double taxation. LLC is then formed from scratch.

Why should you convert?

C-Corp has lower corporate income tax, allows you to be hired as an employee, raise venture capital and pay LLC members dividends.

How to?

Depending on the state of formation, you can have statutory conversion, statutory merger and nonstatutory conversion. Each of this will involve dissolving the LLC and incorporating from scratch.

Comparisons

What are the differences between C-Corp and other entities?

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.

C-Corp vs LLC

C-corp and LLC offer liability protection to the owners, but LLC cannot issue stock to members. Though C-Corp has lower corporate income tax, it could be subject to double taxation.

Read in detail

C-Corp vs LLC

C-Corp vs S-Corp

C-Corp is a business entity, where S-Corp is just a tax classification asking IRS to treat your entity as a partnership. C-Corp is not a pass-through entity, where S-Corp is.

Read in detail

C-Corp vs S-Corp

C-Corp vs DBA

C-Corp is a separate legal entity from its owners and offers personal liability. DBA is not considered separate from its owner and he/she is personally liable for the DBA's debts and obligations.

Read in detail

C-Corp vs DBA

FAQ

C-Corp requires more paperwork than LLC. However, most of them are one-time and may not require a lot of your time. There are a couple of annual reports to be filed with the federal and state agencies.

C-Corp needs to hold at least one annual shareholder's meeting. This does not have to be in a luxury resort. It can be as simple as an online meeting. However, you'll have to ensure meeting minutes are maintained and that every shareholder is issued a notice. Board of Directors meetings can be called when there are important business to discuss that affects the entire corporation.

You can avoid double taxation in a C-Corp by hiring shareholders as employees and paying them salaries instead of issuing dividends. If the corporation issues dividends, there will certainly be double taxation. Many shareholders avoid this issue by either taking a salary or by not issuing dividends at all.