Episode 36 | 24 Mins
Choosing a C Corporation | 6 Things to Consider
How do you know if a C corporation is right for your business? A C Corporation is the default corporation type. Many people consider C Corporations to be for big companies, but they can be beneficial for smaller businesses too.
(this transcript has been edited to improve readability)
On this episode of #TaxTalk, we’re going to be talking about the six things that you should consider when it comes to creating a C corporation for your business. Now we talked about the six things, in general, a couple of episodes ago. We talked about those six things and how they apply to sole proprietorships. We’ve talked about how they apply to partnerships. And we’ve talked about how they apply to S corporations. And today we’re going to be talking about how they apply to C corporations.
If you have not watched or listened to any of those episodes that we’ve already talked about, click here to go back to the very first one. In the first episode, I go into a little bit more detail about what each of these six things is. Make sure you download the workbook that goes along with these episodes so that you can jot down your notes for what you want in your business. You can then see how your notes compare to each of these different business entities. That way, you can determine which one is right for you based on your deal breakers, your things that you have to have, and things that are nice to have but are not necessarily a big deal.
If you have already watched or listened to those episodes, and you’re ready to find out how these six things that you should be considering when choosing the right business entity, apply to C corporations, we’ll get right into that right after this.
As a quick recap (that I always do at the beginning of these episodes), the six things that you should consider when choosing a business entity are continuity of existence, limited liability, transferability of ownership, centralized management, capital, and tax implications.
As mentioned before, today we’re going to be talking about how those six things apply to C corporations. Before I start, I just want to mention that if you listened to the S corporation episode, and you’re listening to this episode, you’re gonna see a lot of similarities. Remember if you are creating an S corporation, what you’re really doing is creating a regular ol’ corporation at the state level, then asking the federal government – the IRS – to tax you differently at the federal level. Of course, some states will also follow suit.
When you create a corporation at the state level, regardless of whether it’s going to be a C corporation or S corporation, for the most part, a lot of the things are going to be similar. There are just a few changes, which of course we’ll go through in this episode, but you might get a sense of, “This sounds like deja vu. I’ve heard this before”. That’s because a lot of the things are going to be very, very similar to the S corporation episode.
Alright, so let’s go ahead and get into how these six things that you should consider when choosing a business entity apply to C corporation.
CONTINUITY OF EXISTENCE
Of course, the first thing that we have is continuity of existence. And we talked about with S corporations, when you create a corporation, you’re creating a completely separate legal entity from yourself. Unlike a sole proprietorship where the business is the same as the owner, when you create a corporation it’s a completely separate entity. Although it is not a real person, it is considered to be a completely separate standalone entity from you. Therefore it can go on into perpetuity even if you decide that you no longer want to be a part of the business, if you are incapacitated in a way where you can’t continue to operate in the business and you want to sell it, if you die, etc.
Whatever happens, if you’re no longer part of the business, that business will continue to exist. It can continue to operate as long as there’s somebody there to operate the business.
If you decide, “You know what, I don’t want to do this anymore. I’m out. I don’t want to sell t-shirts anymore. I don’t want to be an influencer anymore because the pressure is getting to me.” or whatever, and you decide to abandon the business, it still is going to exist until you go ahead and go to the state – just the same way you went to the state to create it, you’ve got to go to the state to close it.
Otherwise, you might still get letters from the state and you might still get letters from the IRS looking for tax returns because you haven’t closed the business.
Because it’s going to go on into perpetuity, so you can sell your shares to somebody else. You can bequeath your shares to a beneficiary if you were to pass away, and the business would still exist. But you have to make sure that if you no longer want the business to exist, you have to actually close the business.
The second one is limited liability. With a corporation, again just like with an S corporation, you have limited liability as a shareholder. As long as you have not done anything to pierce the corporate veil, which again means that you’re basically treating the business as though it’s not a separate entity.
You’re commingling funds. You don’t have a separate business bank account. You have all of your business income going into your personal bank account. Or you do have a separate business bank account, but you’re using that business bank account to pay personal expenses, instead of paying yourself and then paying personal expenses out of it. Any kind of way that you’re really just treating the business, the corporation, as though it’s really just an extension of yourself and not a completely separate entity. If your business were to get sued, for whatever reason, then the person that’s bringing the lawsuit against you might have an argument that you are not treating the business as a separate legal entity, and therefore they should be able to come after your personal assets, instead of just whatever assets are in the business.
With a corporation, if the business were to get sued, then typically, you can lose your investment in the business, and the corporation could lose all of its assets if there was not enough insurance to cover what was going on or enough money to cover what was going on. The corporation could be forced to liquidate its assets.
But if you pierce the corporate veil, or if the courts pierce the corporate veil, and say that you are not treating this business as a completely separate legal entity, instead you’re treating it as an extension of yourself – more like a sole proprietorship – then they could actually come after you personally for whatever judgments are against the corporation. So you do want to make sure that you understand that it’s super, super important that you do treat your corporation as a completely separate business.
TRANSFERABILITY OF OWNERSHIP
The third thing to consider is the transferability of ownership interest. Again, just like with S corporations, you are a shareholder in the company. You can transfer your ownership interest to anybody that you want to without any other approval from any of the other shareholders or the management if you have management. The difference here between a C corporation and an S corporation is there is no restriction on who can own a C corporation.
Remember with the S corporation you couldn’t have more than 100 shareholders and the owners could not be a partnership, or another corporation or a foreign person, right. But in this case, you can have Chinese investors, you can have Russian investors, you can have German investors, you can have Nigerian investors, you can have Australian investors. You can have a partnership that owns a corporation, although I don’t really understand why you would want to – but you can have a partnership that owns the corporation. You can have another corporation that owns a C corporation if you wanted to have a multi-level, organizational structure like some of these really, really big companies do.
You do not have any limits on who can own the shares in a C corporation unless you write that into the articles of incorporation as a restriction on who can own it. So that’s another thing to consider, just like you can freely transfer your shares to anybody else, your fellow shareholders can do the same. So if you want to have it written into your Articles of Incorporation that you restrict who can own the shares, or you have to have a meeting before anybody sells the shares, you can write that in. But just understand, if you don’t have any specific language, about transferring ownership, then any of the shareholders can transfer any amount of their interest to anybody, without approval from anybody else.
The fourth thing to consider is centralized management. Now, with a C corporation – if it’s a smaller C corporation, typically the people that own the business are going to be the ones who are making the management decisions. So that’s going to be more of a centralized management situation. But with a C corporation, you can also have decentralized management. You can bring on somebody to manage the company and you’re more of just a hands-off person. You’ve invested in the business, you own the business, but you don’t really work in the business. You just kind of use the business as an income-generating stream for you, and you have somebody else handling all that stuff.
That’s the difference between centralized and decentralized management. You can have either one in your business.
Obviously, the more complicated the business is, or the bigger it is, then you might want to bring on somebody to actually handle the business for you. A lot of you may not know this, but I used to be in a lot of MLM companies. And I was in one where they definitely could have benefited from hiring somebody to actually manage the business. It became a multi-billion dollar business, and they just were not really equipped to handle that size of a company. So it really would have benefited them to bring in somebody to have those management decisions or to do those management decisions or to manage the company, and they kind of just are on in the advisory role, but they didn’t do that. And the company went to crap, as far as I’m concerned.
Anyway, moving right along to number five, capital. Again, with C corporations, you are completely unlimited with who can be investors in the company. So again, with S corporations, we talked about there is a limitation on who could actually own the company. So you were kind of limited in who you would bring on as an investor in the company. But with C corporations, you can bring on anybody as an investor.
You can have multiple classes of stock so that you can have give preferential treatment to some investors. When I say preferential treatment, they get first priority access to dividends, they might get bigger dividends, etc, to give them an incentive to invest in your company. But on the flip side, they don’t have voting rights in the company.
With the S corp, you can only have one class of stock. Everybody has the same access to the same shares, which meant that they get the same voting rights. With a C Corp, you can actually split it up to where certain investors that you might not want to have voting rights in the company, they might get a bigger dividend. They might get more preferential dividend, but they don’t get voting rights.
And last, but not least, my favorite consideration: tax implications.
Let’s talk about the tax implications for a C Corp. There are so so so many things to consider, from a tax perspective, for all of these business entities. We will get into those later on down the line in their own separate videos. But for the purpose of this, this episode, we’re going to talk about just a couple.
First of all, a C corporation is the only business entity that is not considered to be a flow-through. We talked about the fact that partnerships, sole proprietorships, and S corporations are flow-through entities which means that particular business entity does not pay tax. Only the owners pay the tax. With the C corporation, the business itself pays tax, and it pays tax at a current flat rate of 21%, based on the Tax Cuts and Jobs Act (aka tax reform) that reduced the corporate tax rate down to a flat 21%.
Whatever your profit is from your business is going to be taxed at 21%. So after the company pays tax on its profits, if you as the owner or the shareholder take a dividend, or if you take a distribution from the company that’s considered to be a dividend, you have to pay tax on that dividend on your tax return. You have to include it in income, and you pay tax on it depending on what your tax rate is. So the company pays tax on the first level. And then out of that after-tax money, you take a distribution, and you have to pay tax on it on your tax return.
Now, this is going to scare some people away. Some people are like, “I don’t want to pay tax twice”. But there is room for C corporations, even with small businesses. There are instances or situations in which it still makes sense to do a C corporation versus an S corporation, even though there’s this double taxation thing.
Quick example, if you have $100,000 in profit from your C corporation, you’re going to pay tax at the 21% tax bracket. However, if you don’t take any money from your business, and instead you reinvest your profits into the business for the next year to generate more income or invest in equipment, there’s no distribution to you as a dividend. Which means that there’s no double taxation. You haven’t taken a distribution, you haven’t taken a dividend. There’s nothing for you to pay tax on, on your personal return.
In contrast, if you have an S corporation and you have that $100,000 of profit, it flows through to you on your personal return because you don’t pay tax at the corporate level, then that money may flow through to you at a higher than 21% tax bracket, even if you choose to still reinvest that hundred thousand dollars into the business. You’ve paid tax on it, it could be at a more than 21% tax bracket, and you don’t even have the cash to pay the tax from the business. You might take the money from the business to pay the tax and then reinvest the rest of it into the business. But you’d have less money to reinvest in this scenario than if you paid tax at the 21% corporate rate.
Now, that’s NOT me saying to go run out and create a C Corp. There are projections that need to be run. And in some cases, it makes sense. In some cases it doesn’t. So don’t go out and create a C Corp because Kesha said C corps are better than S corps. That’s not what Kesha said.
Double taxation is one thing when it comes to tax implications. And like I said, you would be paying tax on any dividend distributions or your personal return based on your tax rate. We talked about how double taxation means that the corporation pays tax at the 21% tax rate, and if you take any dividend distribution, then you pay tax at your tax rate. However, as long as it’s considered a qualified dividend, the dividend tax rate is a lot lower than your regular marginal tax rate. You might be in the 20-something percent tax bracket for your regular income, but may only have to pay zero or 15% on your actual dividends. So you still could save a little bit more money on your dividends from your corporation than you would if you were flowing money through from an S corp, partnership, or especially a sole proprietorship. The tax code favors people who own businesses, and people who invest in businesses, much more than they favor people who work in businesses.
QUALIFIED BUSINESS INCOME DEDUCTION
With sole proprietorships, partnerships, and S corporations, we talked about this concept of the qualified business income deduction. This deduction allows you to take a deduction of up to 20% of your business income. However, that deduction is not available for C corporations, because it’s not a flow-through business. That deduction is only available to flow-through entities. With a C corporation, you’re going to be paying tax on all the profit. With flow-through entities, you’re only paying tax on about 80% of the profit.
If the corporation itself has a loss, that loss does not flow through to your personal return. You would have to wait for the corporation to generate additional income to be able to take that loss. The Tax Cuts and Jobs Act allows losses to be carried forward indefinitely. In the past they were limited to a certain period of time.
NET OPERATING LOSSES
If you have losses in your business for the first couple of years and then eventually start turning a profit, you’re still going to be able to shield your income from tax because you have those net operating losses built up. A net operating loss is the loss that you’ve taken in a prior year. You can use that to offset your income in a future year, but it doesn’t flow through to you as the owner. You can’t use that on your personal tax return to offset any other income from your personal tax return. It stays with the company and it continues to be carried forward until the company has a profit big enough to be able to take it.
This is something that big corporations consider all the time. Some companies have billions of dollars (hello, Amazon) in net operating losses that they’re able to continue to utilize in future years. That’s part of the reason why companies like Amazon and other big companies are able to generate profits and not pay tax because they lost a lot of money in the beginning.
As you can see, there are a lot of different tax considerations that you want to take into account when you are deciding what type of business entity you want to use. Make sure you talk to a tax professional and a lawyer so that you can get the big picture of all of these different business entities and make the best decision that’s going to work for you. I’ve said this before: the best business entity for you may not be the one that gives you the most tax savings. You should not be choosing a business entity specifically based on the tax savings alone.
Whatever business entity you choose, people like me are going to help you reduce your tax liability as much as possible. We might even consider looking at different business entities for the tax benefits. That’s why it’s really important for you to understand why the business entity you have is the best for your business.
It’s also important to understand that just because this one is the best for your business right now doesn’t mean it’s going to be the best for your business in five years. It’s absolutely fine if you have to change later on down the line. I just wouldn’t change your business entity every year. But it’s okay to decide that you want to change your business entity in the future.
That’s all I have for you today. Thank you so much for listening and or watching depending on how you are consuming this episode. Next week we’re going to talk about the super LLC and how these six things apply to LLCs.
Here’s a hint: you already know everything you need to know! But we’ll talk about it anyway, make sure you come back for that.
Remember, if you haven’t listened to any of the other episodes, make sure you go all the way back to the beginning and check out the very first episode and download that workbook. Jot down your ideas for each of these six things and what you want in your business. Then go back through these episodes and see how what you want stacks up to all of these business entities so that you can make the best-informed decision for yourself.
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