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When you’re in business, you may choose to operate as a corporation instead of an LLC. Whether you’ve already incorporated or you’re just getting started, it helps to know some fundamentals.
A C Corporation (C Corp) is a separate entity – it can own its own property, enter into contracts, sue or be sued in court, and lend or invest money. The entity is created once you incorporate in a state. Like other business entities, corporations file annual reports. The business owners of a c corporation are called shareholders.
Corporations are owned by shareholders (or stockholders) and managed by directors and officers. A corporation could have hundreds or thousands of shareholders.
CT Observation: Forming a corporation may be a good choice if you eventually want an IPO (initial public offering). Also, many venture capitalists, angels, and other investors prefer a corporation over an LLC.
A corporation’s board of directors is elected by shareholders and is responsible for overseeing corporate business and affairs. Corporate officers carry out the day-to-day management of the corporation.
Corporate bylaws contain the basic rules for conducting the corporation’s business and affairs. They typically cover things like directors’ committees, shareholders’ and directors’ meeting formalities (e.g., date, place, and notice), office location, and the powers, duties, and qualifications of directors and officers.
CT Observation: In a closely held corporation with a handful of shareholders, individual business owner(s) typically wear many “hats” at one time: shareholder, officer, and director. Also, even though stock is “technically” freely transferable, closely held shareholders typically enter into buy-sell agreements or other agreements.
The process of incorporation involves properly filing your Articles of Incorporation, designating your registered agent, and paying the state’s fee. You’ll also typically hold an organizational meeting and adopt corporate bylaws.
Each state has its own rules on what it asks for in the Articles of Incorporation. Typically, articles of incorporation contain:
Some states may also ask for the corporation’s purpose (e.g., a general purpose like “any lawful business”) and for names of initial directors. Optional items in the Articles of Incorporation include provisions regarding management and the rights, powers and authority of directors and shareholders.
After the Articles of Incorporation are filed, an organizational meeting is held to complete organization of the corporation. Often, a “paper meeting” is held and a signed statement of the action taken is filed in the corporation’s minutes book.
Once you’ve incorporated and your corporation exists, it may have some choice in whether it’s taxed as a “C Corporation” or an “S Corporation.”
Under IRS rules, a corporation is automatically a C Corporation. But, if it qualifies, you could make an IRS election to be an S Corporation instead.
CT Observation: The difference between an S Corporation and a C Corporation is an IRS tax difference. Regardless of which IRS tax status it has, it’s simply a “corporation” for purposes of state business entity compliance.
In other words, when you incorporate, the corporation you form with the state could end up in the IRS’s eyes as a C Corporation or an S Corporation.
CT Observation: State tax rules and federal IRS rules may differ. Even though a good number of states recognize federal S corporation tax status, some don’t. Also, a state may have its own election rules. This should also be addressed when talking with your advisor.
The names “C Corporation” and “S Corporation” come from subchapters of the Internal Revenue Code. Federal tax rules for C Corps appear in Subchapter “C” of the Internal Revenue Code. Federal tax rules for S Corps appear in Subchapter “S” of the Internal Revenue Code.
CT Observation: To qualify to get S Corp tax treatment from the IRS, you have to satisfy some fairly strict tax rules – including (but not only) an IRS election. The trade-off for jumping through all of the IRS’s hoops to be taxed as an S Corp is that, in contrast to C Corp owners, an S Corp’s owners enjoy pass-through taxation.
If you’d prefer pass-through taxation or you’d like more information on S Corps, see our S Corporation discussion to read more about S Corps.
C Corporations are separate taxpayers for federal income tax purposes. A C Corp files its own federal income tax return and pays its own income taxes (similar to an individual).
Because of this, dividends paid to shareholders are widely known for “double-taxation.” The C Corp pays tax on its income. And, shareholders generally must pay taxes on C Corporation dividends. This means that the income is taxed twice: once to the C Corporation and a second time to the shareholder.
A less-widely known tax aspect of C Corporations is that with the proper planning, owners could avoid, or significantly lessen, double-taxation by using other tax-savings strategies available to C Corps. For example, owners may be able to keep earnings in the business for reasonable purposes (instead of distributing any taxable dividends).
Also, C Corp owners might be able to achieve a lower tax bill with a combination of salary-and-distributions and a reduced (or no) taxable gain on the sale of certain qualifying stock. For a qualifying business, the favorable Internal Revenue Code Section 1202 gain reduction (or in some cases, exclusion) available to C Corporations could be highly beneficial come tax time.
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