Those wanting to start a business will need to make a decision about how to structure their business. This will need to be done first with the help of their attorney and accountant. One of the types of business structures is a C-corp.
C-corp is named after the C subsection of the Internal Revenue Service (IRS) tax code. This is where this particular structure is defined. There are advantages and disadvantages of being a C-corp so it’s best to understand it fully before deciding.
We’ve created a guide to help you through deciding whether C corp certification is right for you. It offers an explanation and some advice on how to get started if that’s your choice.
What is a C-corp?
A C corporation is a business entity where the entity pays its own income tax and the owners or shareholders are taxed separately on profits they receive from the business. This process is known as double taxation since both the owners and the business are taxed on profits.
This business model is the most used in legal structures for business and its primary benefit is that it separates the owner’s income and personal assets from that of the business.
It’s a legal entity that is independent and owned by its shareholders.
The different types of corporations
There are three types of corporations in the United States listed for IRS tax purposes. Each is different primarily in how it’s taxed and its liability protection for the owners or shareholders.
This company pays corporate income tax at the corporate level and pays again on the personal level through income tax returns.
Put simply, the company files a tax return and so does each owner.
While this is double taxation, owners do have more protection because their assets and profits are considered independent from the business.
Business owners with an S-Corporation status can pay themselves a salary or take distributions and have the tax advantage of not paying self-employment tax to the government. Profits left at the end of the tax year can also be given to you without facing additional tax penalties.
Limited Liability Company (LLC)
An LLC offers limited liability protection and pays you a salary. You typically don’t get the profits left over at the end of the year. In this model, you pay on your taxable income just like you would if you worked for someone else.
Who should form a C-corp?
Most of those who form a C-corp are extremely large companies like McDonald’s or Starbucks. They have many investors and typically trade shares of stock on the market.
Entrepreneurs may consider forming a C-corp if they have many investors and are dealing with a substantial amount of money over several locations. In most cases of startups, an S-corp, or LLC would be a better option.
Advantages of starting a C-corp
There are three key advantages to starting a C-corp:
Investors’ assets and dividends are separate from that of the business so someone can’t sue a shareholder as part of a business lawsuit. Only the business entity can be sued.
Shareholders can only lose the money they invested if the business fails. They are not responsible for debt should the business file bankruptcy.
A C-corp stands a better chance of luring investors because it protects them from risk. This includes those who want to provide large amounts of equity financing and venture capital. That makes it easier for a C-corp to grow quickly.
Disadvantages of starting a C-corp
Every type of business entity has its drawbacks and the C-corp model has disadvantages too.
The business is taxed first on its profits. Then, shareholders pay personal income tax on their profits since it’s a separate entity from them.
There is a lot of paperwork involved in setting up a C-corp. You will need an accountant that has a keen knowledge of how to do it properly to follow all the IRS regulations.
You must register the C-corp with the Security and Exchange Commission (SEC) at certain threshold moments.
A C-corp is under different government rules. One such rule is to host annual meetings with all stockholders. You must also have a board of directors with members voted in, set bylaws, and a strong understanding of corporate tax rates and the internal revenue code.
Lack of owner control
As a business owner, you don’t have much control over the entity. Shareholders and the board of directors make major decisions while you run daily operations as a CEO. You earn your dividends and have a say but will report to the board.
Steps to set up a C-corp
Each state has rules for setting up a C-corp so you will need to go to your Secretary of State’s Office website to find out what the exact rules are for your area. However, there are some basic things everyone looking to start a C-corp must do.
1. Create a business plan
You should have a plan of how you are going to run your entity in place before you start putting action on it. This is something you are going to need to attract investors. A business plan identifies what your business does or sells, how it will do it, the market for it, and long-term projections.
2. Register a business name
The first thing you will do is pick a business name and register it with the state. It must be a name currently unregistered. You find out if your preferred name is being used by doing a business entity search on the Secretary of State’s website.
3. File Articles of Incorporation
Every state has methods of filing for Articles of Incorporation, sometimes called Certificate of Incorporation. Forms and instructions are found on the Secretary of State’s website for your state. You’ll provide basic information like the company address, purpose, and its registered agent.
4. File an SS-4
An SS-4 is a federal application for an Employer Identification Number (EIN). You must have an employer identification number, or EIN to hire employees, pay payroll taxes, to the state and federal government, and pay unemployment.
5. Determine how much capital you need
Before you can pitch your idea to possible investors, you will need to get specifics of how much capital you will need to start up and when they could see a return on their investment. This is the most important part of your startup plan so you will need to do some research to make sure it’s accurate.
6. Open a bank account
You will need an open checking account in the name of the corporation. This is how you will receive investments and start operating your business. You will need to eventually open a separate payroll account to pay employees and payroll taxes.
7. Get your initial shareholders
You will need some initial investors to start your business. It is up to you how many you will need based on your business model, your product or service, and the amount of money you need to start up.
Typically, your first investors are people who know you but you can also pitch your plan to others like venture capitalists.
8. Set up your board of directors
Your shareholders will help you set up and vote on a board of directors. This is important to prevent a legal quandary of you running the business for personal gain rather than for the benefit of the shareholders.
What resources are available to provide further assistance?
Many organizations exist that can answer questions and help you decide if you need to establish your business as a C-corp. Here is a list that can help.
SCORE is a volunteer organization that helps all types of business owners as they start and manage their businesses. It includes mentor programs, free business consultations, seminars and webinars, and links to resources that can help raise capital and provide for other business needs.
The Secretary of State Office in your state has a wealth of resources for you to consider as you start a business. It also provides forms and details on how to submit them.
The SBA has information about all types of businesses and what’s involved in starting each entity type. It also has information on SBA loans and other programs offered to small businesses and entrepreneurs.
The Chamber of Commerce is your connection to the business world. It has resources about capital, marketing, and other aspects of growing your business.
The IRS has all of the forms and explanations on income tax rates and personal tax returns. It also has forms to apply for a federal EIN.
What would the tax difference be between a C-Corp and an S-Corp?
The C-Corp would be considerably more in taxes than an S-Corp. For instance, an S-Corp may pay $4,259 in taxes and the same company with identical profits would pay $21,000 as a C-Corp.
Why would I want to start a C-Corp?
There is one good reason to start a C-Corp. You need investors and more than the average amount of money to start your business. Businesses that need a lot of equipment, vehicles, or high-tech protocols are the ones that start out as C-Corps because the entrepreneur could never get that much funding as a start-up.
How do I fund the initial aspects of a C-Corp?
You will be the first investor. You can fund it by depositing personal money into the corporation account to start a capital fund for the business. Legally, this is a loan to the corporation. It can also be traded for stock shares in the business.
Can I pay myself a bonus with a C-Corp?
Yes, you can pay yourself a bonus but whether that is something you can approve or must go through the board of directors is another question. Typically, the board would approve your bonus as CEO.
All bonuses are treated as wages so you will need to pay the Medicare and Social Security Tax on them.
Why do investors like C-Corps?
The primary reason investors like C-Corps is because they are only taxed when they receive dividends. They aren’t taxed if the company doesn’t make a profit.
Are C-Corp owners considered employees?
You are defined as an owner-employee in a C-Corp so you are shielded from lawsuits and debts. You get a salary that comes from company profits, just as any other employee. You can also own stock and issue stock if you choose to invest.
Can you have a single-member C-Corp?
There are individually owned C-Corps. In that case, you are also the majority shareholder as well as the owner. Small businesses that incorporate are automatically considered C-Corps until they file an election form with the IRS stating differently.
Do C-Corps pay capital gains taxes?
There is no preferential treatment with C-Corps regarding long-term capital gains. Its capital gains are part of ordinary income with all other income.
What happens if the C-Corp has a loss?
As shareholders don’t pay taxes until they receive dividends, they also can’t claim a loss on their taxes if the C-Corp loses money. This is considered to be a disadvantage of a C-Corp over an S-Corp. Losses can only be applied to corporate income. However, losses can be carried forward or backward to offset income in other taxes years to reduce taxes.
Which is best, C-Corp or S-Corp?
It really depends on what you are trying to accomplish with your business entity. Most small businesses are S-Corps because the tax aspects are better for small business owners. However, those who want to seek a lot of capital and set up a large-scale business would find forming a C-Corp would be better.
What if the C-Corp closes?
All debts would be settled for the C-Corp closing and any remaining money from sales of equipment or the business would be divided among shareholders. The board would need to vote to close the business before the process could start.
What are the responsibilities of the board?
Exact responsibilities are spelled out in the company charter and business plans. However, the overall responsibility is to make sure shareholders earn as much money as they can. This is the board’s fiduciary responsibility and failing to do that would make the board members subject to lawsuits from the shareholders.