C Corporation: Higher Taxes, More Flexibility - NerdWallet (2024)

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C Corporation: Higher Taxes, More Flexibility - NerdWallet? ›

The main reason to set up your small business as a C-corp is to be able to tap into a bigger pool of investors and have more options for expanding your company. You wouldn't have to rely heavily on small-business loans. But adopting this business structure would probably saddle you with a bigger tax obligation.

Corporate-level income taxes

As mentioned above, C Corporations pay tax at the entity level. This entity level tax is different than the tax other businesses pay because it is a flat 21% tax. Other entity types, such as sole proprietorships and partnerships, will pay tax based on the owners' individual income tax rate.

Split income.

Because progressive tax brackets affect C corps and individuals, income splitting can minimize double taxation. By taking a tax-deductible salary and leaving the rest of the profit for reinvestment, you reduce your personal gross income and the business's taxable income.

As explained above, one major disadvantage for C corporations is that profits are effectively taxed twice, first on the company's income taxes, and again when shareholders receive dividends. An S corporation is a "pass-through" entity, meaning that it does not pay corporate income taxes.

Lower audit risk — Generally, C corporations are audited less frequently than sole proprietorships. Tax deductible expenses — Business expenses may be tax-deductible. Self-employment tax savings — A C corporation can offer self-employment tax savings since owners who work for the business are classified as employees.

From a tax standpoint, C corps also provide advantages for smaller business owners, such a mechanism for avoiding the self-employment tax and greater flexibility when it some to deductions, salaries, and dividend distributions.

For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.

This means a C corporation pays corporate income tax on its income, after offsetting income with losses, deductions, and credits. A corporation pays its shareholders dividends from its after-tax income. The shareholders then pay personal income taxes on the dividends. This is the often-mentioned “double taxation”.

C corporations may distribute money or property to shareholders. The method used to make a corporate distribution will determine the tax consequences of the withdrawal.

On the special type of corporation of interest to small businesses is the Subchapter S corporation. This type of corporation avoids double taxation by having its income taxed to the shareholders as if the corporation were a partnership.

How do C corp owners get paid? ›

Officers of C corporations are strictly paid on a salary basis. They may be able to obtain bonuses, but their primary source of income is their salary. In an S corporation, an owner can choose to take regular draws or distributions in addition to their normal salary.

However, C-corps may offer more tax benefits in the long run. While LLCs are pass-through entities where profits and losses pass to the owners' personal returns, C-corps allow business losses to offset income earned. C-corps can also potentially qualify for more business tax deductions.

Investors prefer C corporations over S corporations and LLCs because shares in a C corp are freely transferable. By design, C corps have a well-established, standard framework for the issuance and distribution of equity (stock and stock options).

C corporations provide the legal and tax structure that aligns with the needs and preferences of venture capitalists, making them the preferred choice for attracting investments. C-corps offer more flexibility to VC investors than S-corps. Some VCs cannot invest in any other type of entity due to managing public funds.

Preferred Stock Issuance: C corporations can issue preferred stock, which provides certain rights and preferences to shareholders. This ability allows venture capitalists to negotiate and structure their investments in a way that aligns with their objectives and risk appetite.

As of the 2017 Tax Cuts and Jobs Act (TCJA), a C Corporation's profits are taxed at the flat 21% corporate income tax rate. Depending on the location and shareholders' personal tax situation, the flat tax rate may work in the business owners' favor.

What are the key differences between S-corp and C-corp? One main difference is that C-corp owners pay a corporate tax to the federal, and sometimes state, governments, while S-corps don't. S-corps owners are limited to 100 shareholders and must file a special form with the IRS to elect S-corp status.

While LLCs are pass-through entities where profits and losses pass to the owners' personal returns, C-corps allow business losses to offset income earned. C-corps can also potentially qualify for more business tax deductions.

Corporation tax advantages

The tax advantages of corporations include: The potential to minimize Medicare and Social Security taxes for shareholder-employees. However, you'll also have the additional cost and hassle of managing payroll if you don't have other employees.