Choosing a Business Entity? The Pros and Cons of a C Corporation

• Learn the formalities of setting up a C corporation to ensure it is treated as a separate entity.
• Discover the potential disadvantages of owning a C corporation.
• Find out how to provide benefits and raise capital with your C corporation.

If you’re launching a new business venture, you’re probably wondering which form of business is most suitable. Below, Fiducial offers a summary of the major advantages and disadvantages of doing business as a C corporation.

A C corporation allows the business to be treated and taxed as a separate entity from you as the principal owner. A properly structured corporation can protect you from the debts of the business yet enable you to control both day-to-day operations and corporate acts such as redemptions, acquisitions, and even liquidations. In addition, the corporate tax rate is currently 21%, which is lower than the highest noncorporate tax rate.

Following formalities

So, how do you ensure that a corporation is treated as a separate entity? You must observe various formalities required by your state. These include:

• Filing articles of incorporation,
• Adopting bylaws,
• Electing a board of directors,
• Holding organizational meetings, and
• Keeping minutes of meetings.

Complying with these requirements and maintaining an adequate capital structure will help ensure that you don’t inadvertently risk personal liability for the debts of the business. For the utmost certainty in maintaining the corporate shield against personal liability, an attorney should be consulted.

Potential disadvantages of a C corporation

Since the corporation is taxed as a separate entity, all items of income, credit, loss, and deduction are computed at the entity level in 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. Thus, owners generally cannot deduct them. However, if you expect to generate profits in year one, this might not be a problem.

Another potential drawback to a C corporation is that its earnings can be subject to double tax. Taxation can occur once at the corporate level and again when distributed to you. However, since most of the corporate earnings will be attributable to your efforts as an employee, the risk of double taxation on that score is minimal since the corporation can deduct all reasonable salaries that it pays to you. However, appreciation in value of the corporate business can lead to double taxation when the business is sold and the profit from the sale distributed.

Providing benefits, raising capital with a C corporation

Business owners can also use their C corporation to 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 to you.

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 tailored to fit your needs and those of potential investors. Also, if you decide to raise capital through debt, you can deduct interest paid by the corporation.

Although the C corporation form of business might seem appropriate for you at this time, you may in the future be able to change from a C corporation to an S corporation, if S status is more appropriate at that time. 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 5 years of the change.

The optimum choice

This is only a brief overview. Have questions? Want to explore the best choice of entity for your business? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.

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