The corporate structure of a business can take two forms: C corporation or S corporation. The choice depends on the number and makeup of the owners and how they want the corporation to be taxed. Most growing companies choose the C corporation structure because of its better flexibility in financing growth and its attraction to shareholders.
What Is a C Corporation?
A C corporation is a legal structure of a business that limits the financial and legal liabilities of the owners, directors, officers and employees. It is treated as a separate entity by the Internal Revenue Service, and its income is taxed at corporate tax rates.
When setting up a new business, the owners decide which corporate form to use. Each type of corporation has its advantages and disadvantages.
Advantages of a C Corporation
The advantages of a C corporation include:
- The unlimited ability to raise capital by selling more stock or issuing convertible debt.
- It's the best choice to take a company public because stocks can be freely traded.
- There is no limit to the number of shareholders.
- Shareholders can be other corporations, partnerships and trusts.
- C corporations can have different classes of shares.
- Employee performance can be rewarded with incentive stock options.
- A large number of deductions and expenses are allowed by the IRS, particularly employee fringe benefits. The IRS allows a C corporation to deduct payments for an employee medical plan, but these payments are not considered income to the employees. In effect, these are tax-free benefits for employees.
- A C corporation has a credit rating that is independent of its owners.
Disadvantages of a C Corporation
The disadvantages of a C Corporation are:
- The possibility of double taxation. A C corporation pays taxes on its corporate income. Then, if the company disburses dividends to its shareholders, they must pay taxes on their income tax returns. In effect, corporate income can be taxed twice.
- C corporations require more paperwork than S corporations. They must hold formal shareholder and board meetings each year and maintain accurate minutes of these meetings. The government conducts more oversight over C corporations because of complex tax regulations and the protections provided to shareholders from responsibility for debts and lawsuits.
- Corporate losses of a C corporation cannot be deducted by the shareholders, unlike with an S corporation.
- A C corporation usually requires an accountant because the tax forms and regulatory filings for C corporations are complicated. Owners may prefer to spend their time working in their business and selling their products, not filling out endless reports for state and federal government.
Differences Between C and S Corporations
C corporations and S corporations both offer limited liability protection, have shareholders, directors and officers and require the filing of Articles of Incorporation. However, they have differences in tax rules and type of ownership.
- An S corporation has only one level of taxation, whereas a C corporation has the possibility of double taxation.
- An S corporation is limited to 100 shareholders who can only be individuals. A C corporation can have an unlimited number of shareholders of any type including other corporations, partnerships and trusts.
- An S corporation cannot have multiple classes of stock. A C corporation can have different classes of stock.
How to Establish a C Corporation
The steps to set up a C corporation are:
- Decide on the state of incorporation.
- Decide on a name and address of the corporation and register with the state.
- Write the Articles of Incorporation, shareholder agreement and bylaws.
- Decide the number of shares of stock authorized, classes of stock and par value of each share.
- Designate a board of directors and officers.
- Appoint a registered agent.
- Obtain a federal employer identification number from the IRS.
Many new business owners start out with an S corporation and change to a C corporation as their business grows. C corporations have more flexibility in raising capital because they have more shareholders and issue different classes of stock. The major disadvantage of a C corporation – the possibility of double taxation of income – can be offset by increased employee benefits, which are treated as nontaxable income.