What is a C Corporation?
A C corporation is a separate legal business entity, the income of which is taxed through the corporation rather than through individual share holders, unlike S Corporations, which pass profits to shareholders who are then responsible for the tax burden of those profits on their personal tax returns. C corporations are named for Subchapter C of the Internal Revenue Code and C corporations are the default corporate type under that code. This means if another type of corporation is not specified, the entity will be a C corporation automatically when it incorporates. This is why C corporations are also called “regular” corporations.
A C corporation’s shareholders must elect a board of directors responsible for making decisions and overseeing policies for the entity. In most cases, a C corporation is required to report to the Kentucky State Attorney General on financial operations. The C corporation is viewed as an individual tax payer by the IRS. As such, C Corporations are subject to “double taxation” — being taxed once at the corporate level and again on the personal level when dividends are distributed to shareholders.
A major advantage of a C corporation is that its owners have limited liability and are not personally liable for any debts incurred by the entity and they cannot be sued individually for corporate wrongdoing. This “corporate veil” means shareholder liability is limited to their investments in the corporation. Additionally, since the corporation is an independent entity, it does not cease to exist when the owners/shareholders change or die.
Advantages of a C Corporation
- Limited Liability – Unlike sole proprietorships and partnerships, using a C corporation for your small business protects your personal assets from peril should a lawsuit be brought against your business or should business debt accrue. Although the owners/shareholders could lose the amount they have invested in the corporation (their shares), their personal assets, property and holdings are not at risk. It may be cheaper to incorporate than it is to carry expensive, comprehensive liability insurance.
- Raising Capital – Since the corporation has stocks to sell, it may be easier to raise capital than it would be for an individual or a partnership. Investors may be enticed by the potential financial gain from corporate profits. This can help a small business get the funds needed, without taking out loans or paying high interest rates to secure necessary financial capital.
- Fringe Benefits – C corporations can deduct fringe benefits from taxes as a business expense. These may include: group term life insurance, health and disability insurance, death benefits payments to $5,000, and employee medical expenses not paid by insurance. Shareholder employees are also exempt from paying taxes on the fringe benefits they receive if the corporation allows non-shareholding employees to take advantage of these benefits as well.
- Attracting Employees – Corporations can offer stock options and fringe benefits which will be attractive to employees and may result in a higher caliber workforce.
- Continuance of Existence – Stock transfers and the death of individuals does not alter the corporation which exists in perpetuity until legally dissolved.
Disadvantages of a C Corporation
- Double Taxation – As mentioned above, C corporations are treated as an individual taxable entity and are taxed on income. This income is taxed a second time on the personal tax returns of shareholders when dividends are distributed. For businesses which intend to reinvest the majority of profits back into the business, and for smaller businesses which use the bulk of the profits to pay deductible expenses (like salaries, fringe benefits and interest payments) this may not be a drawback to this type of corporation. For those companies planning to distribute most of the profits, it will be a disadvantage.
- Bureaucracy – Corporations have to abide by often intricate corporate laws on state and federal levels (which may involve the added expense of hiring tax preparers and consulting attorneys) and will require the issuing of stock certificates to all stockholders, regular stockholder meetings with recorded minutes and board of directors meetings, also with recorded and filed minutes. These meetings must be held regularly — a minimum of once per year. A corporate record book should be established to hold the articles of incorporation, records of stock holdings, the corporation’s bylaws, and the minutes of board and shareholder meetings. Additionally, all corporate actions require board approval which can make it impossible to take quick action, even on urgent matters. The corporation’s full name (which should indicate the company’s corporate status through use of “Inc.” or an equivalent) must be used on all correspondence, stationary, advertising, phone listings, and signs.
- Expenses – Corporations have to pay state fees where they file articles of incorporation. Corporations are also required to be represented by a lawyer, should they have to bring a case to small claims court (sole proprietors and partners can represent themselves.) Corporations are subject to taxes in other states if they conduct business across state lines. If business activities pose a risk to employees or customers and reasonably priced insurance is available to protect against such risks, such coverage should be secured. Failure to protect the corporate entity from losses and debt can be reason to hold the owners personally responsible by disregarding the corporate status, in the case of a lawsuit.
- Dividend Distribution Rules – Corporate profits are divided based on stocks rather than on capital investment or employment with the company. In some states, the rules governing division of profits for corporations dictate how much can be distributed in dividends. All past operations must usually be paid before dividends can be distributed. Failure to do so weakens the stability of the company and can result in the directors being held personally responsible to the corporate creditors.