What is a Corporation?
In the United States Corporations are the most common type of incorporated business structure and with good reason. Corporations, also known as c-corps, offer infinite growth potential through the selling and sale of stocks, which in turn attracts some very wealthy investors. In addition, there is no limit to the number of shareholders a c-corporation can have.
IRS Definition of a Corporation: A corporation is a legal entity established by a charter granting it certain legal powers, rights, privileges, and liabilities. A corporation can be established by a person or group of people with a charter from the state’s secretary of state. After a corporation is created, it becomes its own entity and generally has an indefinite lifespan.
Taxation and Liability of a Corporation
Unlike an LLC or an S-Corporation taxes, a C-Corp is taxed as its own entity and is subject to income tax, at the below tax rate by the IRS:
Recent Tax Reform eliminated the numerous tax brackets for Corporations and instead imposed a fixed 21% tax rate on C-corp regardless of income.
Corporations are subject to Double Taxation of Profits: the C-Corp itself is taxed, at the above rate, and then the distributions of earning (dividends) made from the C-Corp to the Shareholders is taxed on the shareholders’ personal tax return.
But, owners of a C-Corp can avoid the double taxation by paying themselves a salary OR year-end bonus that will leave the C-corp at earning $0 in income.
If you take a salary from the C-corp, but not the total amount of profit that would bring income to $0, then both the Corporation and the individual will be taxed, but it could be at a lower tax bracket, saving on taxes, rather than taking the full salary. This is known as Income Splitting.
- Leaving $250,000 or less in the Corporation’s bank account as earnings (not distributed to owners) is considered reasonable business needs income. If you leave more than $250,000, the amount over the $250,000 is subject to an Accumulated Earnings Tax of 20%.
Since C-Corps are NOT Pass-through entities, profits and losses are not passed through to the shareholders’ individual tax return in a C-Corp, like they are in a Partnership, LLC, or S-corp. If a C-corp incurs a loss (cost is greater than earnings), the loss can be used to offset income taxes to the corporation that it paid in the last 2 years, or will pay in up to 20 years in the future.
Form 1120: Form 1120 is the form used for a Corporation’s annual tax return.
Qualified Personal Service Corporations:
Certain professions are required to form as a Personal Service Corporation by the federal government and IRS. This means that the IRS will tax the Personal Service Corporation at a flat rate of 35%, regardless of the profits and losses of the business. The following professions qualify to be Personal Service Corporations:
The flat rate of 35% is the highest tax for corporations, so business in these industries may not want to form corporations for this reason.
Liability– the Benefit of Corporations.
- Liability distinct from owners and shareholders: Corporations are treated as their own entity, and like a person, a corporation can own things, rent things, sue or be sued. The advantage of a corporation is that it is liable on its own, and investors and shareholders of the corporation cannot be held personally responsible for actions committed by the corporation.
- Investment friendly entity: For this reason, Corporations (unlike S-Corporations) are the most common entity type for a business that is planning to take on outside investment. The investors are not personally liable, and Corporations allow for easier selling of shares than any other entity type, meaning that an investor knows that they can get out of the investment by selling their shares if they want to in the future.
The drawbacks of Corporations
More legal requirements and paperwork. Corporations are required to hold meetings and record the contents of the meetings in “meeting minutes” or “resolutions” documents. Keeping records and documents of business activity is always a good idea though, no matter what type of entity you are forming.