When deciding on the best structure for your business, one option to consider is a C corporation. This entity offers several advantages and disadvantages that may significantly affect your business operations and financial health. Here’s a detailed look at the pros and cons of operating as a C corporation.
A C corporation allows the business to be treated and taxed separately from you as the principal owner. The corporate tax rate is currently 21%, lower than the highest % noncorporate tax rate of 37%.
One of the primary disadvantages of a C corporation is double taxation. The corporation’s profits are taxed at the corporate level, and then any dividends distributed to shareholders are taxed again at the individual level. This can result in a higher overall tax burden than other business structures. However, since most of the corporate earnings will be attributable to your efforts as an employee, the risk of double taxation is minimal since the corporation can deduct all reasonable salaries it pays.
Because the corporation is taxed as a separate entity, all income, credit, loss, and deduction items are computed at the entity level when arriving at corporate taxable income or loss. One potential disadvantage to a C corporation for a new business is that losses are trapped at the entity level and, thus, generally can’t be deducted by the owners. However, if you expect to generate profits in year one, this might not be a problem.
One of the most significant advantages of a C corporation is the limited liability protection it offers. Shareholders aren’t personally liable for the corporation’s debts and liabilities. Personal assets are generally protected if the business faces legal issues or bankruptcy.
To ensure that a corporation is treated as a separate entity, it’s important to observe various formalities required by your state. These include:
Complying with these requirements and maintaining an adequate capital structure will ensure you don’t inadvertently risk personal liability for the business’s debts.
A C corporation can also provide fringe benefits and fund qualified pension plans on a tax-favored basis. Subject to certain limits, the corporation can deduct the cost of a variety of benefits, such as health insurance and group life insurance, without adverse tax consequences to you. Similarly, contributions to qualified pension plans are usually deductible but aren’t currently taxable.
A C corporation also gives you considerable flexibility in raising capital from outside investors. A C corporation can have multiple classes of stock — each with different rights and preferences that can be tailored to fit your needs and those of potential investors. Also, if you decide to raise capital through debt, interest paid by the corporation is deductible.
Although the C corporation form of business could be appropriate for you now, you may be able to change the corporation from a C corporation to an S corporation in the future if S status is more appropriate. This change will ordinarily be tax-free, except that built-in gain on the corporate assets may be subject to tax if the assets are disposed of by the corporation within 10 years of the change.
This is only a brief overview of the pros and cons of being a C corporation. Contact us if you have questions or want to explore the best choice of entity for your business.
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