There are several key considerations when choosing a business structure. Many people choose a sole proprietorship because it is simple, while others opt for an LLC (Limited Liability Company) because it offers a relatively straightforward structure that provides protection. Depending on your circumstances, you may want to choose a C Corporation.
C Corporations are taxed differently from most small business structures. The most important thing to understand when choosing a C Corp is the idea of business-level vs owner-level taxation. This article explains how C Corp taxes work, what the tax rate is, and how that rate compares to S Corps. Once you understand how these different kinds of taxation work, it will be easier to choose the best one for your business. While you can’t avoid paying taxes, you can find a structure that offers the most benefits for you.
How C corporation taxes work
When you operate as a sole proprietor, your finances are tied to your business. A C Corporation is taxed as a completely separate legal business entity. The business pays taxes on its profits, while owners are taxed separately if they receive income from the business.
C Corps are different from pass-through entities, where the profits pass through to the individual owners’ personal tax returns. Examples of pass-through entities also include LLCs and S Corps. That can result in double taxation.
What is double taxation?
Double taxation occurs when taxes are paid on the same income, asset, or financial transaction. Nobody wants to pay more taxes than necessary, and you can minimize double taxation.
Profits are taxed at the corporate level, directly on the entity that is the C Corp. Shareholders receive dividends, which are then taxed again on their personal tax returns. Double taxation only applies when profits are distributed, but retained earnings are not taxed again at the shareholder level.
When C corp taxation applies
C Corp taxation is the default tax treatment for corporations, and it applies unless the business becomes an S Corp. Not all businesses are eligible to become S Corps, There are several conditions for becoming an S Corp, and there is an application that will determine your status.
What is the tax rate for C Corp?
The federal corporate tax rate is a flat 21%, and that rate stays the same no matter the income level. Any business designated as a C Corp will have to pay that rate. There are special forms for reporting income and paying taxes.
State corporate taxes
Keep in mind that many states also tax corporate income. Rates and rules vary by state and are usually based on profits. Some states have no corporate income tax but may charge other business-related taxes.
Total tax considerations
Paying the correct amount of taxes will help ensure you stay in compliance and avoid future penalties, while also providing more stability when you are either starting a business or growing operations. Make sure you understand what your responsibilities are.
Your overall tax burden may include:
- Federal corporate tax
- State corporate tax
- Taxes on dividend
The 21% federal corporate rate is just a part of your obligation.
What is the difference between S Corp and C Corp taxes?
The main difference between S Corp and C Corp taxes is in how profits are taxed.
Pass-through vs corporate taxation
S Corps pass profits through to the owner’s personal tax return, avoiding the business-level income tax.
C Corps pay taxes at the business level, and then the profits are also taxed if there is a distribution of dividends.
Single taxation vs double taxation
S Corps are only typically taxed once, at the owner level, while C Corps can be taxed again when shareholders receive their dividends. What kind of income this will have depends on how the business handles profits.
How owners are taxed
S Corp owners pay tax on their share of profits, which is more direct, while C Corp shareholders pay taxes on dividends. In an S Corp, income may be taxed even if there is no withdrawal.
Salary and distributions
Providing a salary to business owners is another important distinction. S Corp owners often take a salary plus distributions, which means that they have a steady stream of income directly from the business that doesn’t depend on profits. C Corp owners may also choose to receive a salary, but they can also choose to receive dividends instead; C Corp owners may choose to receive both a salary and dividends.
Whatever choice is made will affect the tax obligation and how it needs to be paid.
Eligibility differences
One of the restrictions on S Corps restricts the number and type of shareholders. C Corps do not have those kinds of restrictions. There are other ways that C Corps are more flexible; tax treatment is one of many factors when choosing a business structure.
Pros and cons of C corporation taxes
No one factor should be the most important when choosing which structure to use for your business. It is important to understand the different rules and restrictions, and you need to consider the future and how you see your business growing. Think carefully about how you want to run your business and what your short- and long-term goals are.
Potential advantages
Some of the most important advantages of choosing a C Corporation include:
- There is a flat corporate tax rate, which makes it predictable.
- With this structure, you can retain earnings in the business, creating value as your business grow.
- There are fewer ownership restrictions, including the potential number of owners.
Potential disadvantages
There are potential disadvantages, although there are ways to minimize their impact.
- Because of the tax structure, there is the risk of double taxation with a C Corp.
- The tax filing requirements are more complex with a C Corp.
- There is a potentially higher combined tax burden with a C Corp.
Not all small businesses will benefit from choosing to be a C Corp.
When C Corp taxation might make sense
Whether C Corp taxation is the best thing for your business depends a lot on your goals. It’s vital to think beyond the day-to-day operation of your business and look at the future. How big do you want your business to be? How do you expect your operations to change as you grow? Here are a few of the reasons people choose C Corp taxation.
- Do you want to attract outside investors? With a C Corp, you can bring in more outside people to support your business. There are no restrictions on the kind and number of shareholders, as there are with an S Corp. You can have as many investors as you want, which means potentially bringing larger amounts of capital to your business.
- How do you want to handle profits? Do you want to distribute them immediately, or do you want to invest them right back into the business? Reinvesting the profits keeps them from being taxed again and adds value to your business.
- What are your plans for long-term growth? If you want to increase revenue fast, you may be thinking about doing more than adding money and basic resources. To achieve long-term growth and scaling, you may want to immediately start working toward adding technology and systems that help your business grow faster.
People who choose C Corp taxation are often looking at these kinds of considerations. You need to think about what kind of product or service you are offering and the best way to achieve your dreams.
Preparing your business before choosing a tax structure
Choosing a tax structure is easier when the business is properly set up and organized. Here are the most important foundational elements of your business:
- The first thing you need to do is choose a business structure, such as sole proprietorship, LLC, C Corp, or S Corp. The best choice is personal and will depend on your goals and how you want to achieve them. As part of that business, you will need
- An EIN (Employee Identification Number) that you will use to identify your business and pay taxes
- Organized financial records are specific depending on business type, and may be part of your application
- A separate business bank account is necessary when operating a business to keep your personal and business assets separate
Some of these business requirements are more complicated, such as many of the business documents. They are important, though, as part of keeping your business in compliance and helping you with long-term planning.
Most people don’t have a lot of experience handling these kinds of matters on their own, but there are platforms like Tailor Brands that assist business owners with all these tasks. They help set up the paperwork and then manage the other basics to ensure your business stays in compliance. This kind of assistance doesn’t change your business obligations, but it will provide a more stable foundation so that you can get on with the more important part of growing your business.
It is important to follow all the right steps when setting up your business. Failure to do so could cause serious problems down the line, including penalties or even rejection of your business applications.
Conclusion
Taxes are an important consideration when choosing a business structure. C Corporations are taxed at the business level with a flat federal rate, but there are potential additional taxes that may apply when profits are distributed.
S Corps and C Corps differ mainly in how and when taxes are applied. While one structure may seem more attractive on the surface, the right choice for you depends on your goals and how you want to use your profits.