C Corporation: Higher Taxes, More Flexibility

A C corporation may be the right business structure for your small business if it's ready for the big time. McDonald's, Starbucks, Apple: Each is a huge business that grew quickly from scratch. Not coincidentally, each is a C-corp.

What are the benefits and the drawbacks of structuring your business as a C-corp? And is your company ready to be one?

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.

Be aware that C-corps are a complicated way to organize a business.

What is a C corporation?

A C-corp, like an S-corp, is a limited liability entity, which means the company, not its shareholders or owners, is held legally liable for the company’s debt and other obligations.

Also, you can bring in an unlimited number of investors when your business is structured as a C corporation. They can be individuals or entities, such as a bank or an investment group, and they can have different ways of being a shareholder of your company through the various classes of stock you’re allowed to issue. Virtually all public companies are C-corps.

However, you’ll have to deal with what the IRS calls double taxation. Your corporation will pay taxes on its profits. And when you pay dividends out to your shareholders, they’ll be liable for taxes on those dividends, even though the earnings were already taxed at the corporate level.

C corporation: Pros

Unlimited investors. Let’s say you want to scale up your coffee shop business so it has a regional or national presence. You need an infusion of cash for that, and as a C corporation, you can have as many investors as are willing to purchase a chunk of your company. Those shareholders can be businesses or individuals, foreign or domestic.

You’ll also be able to offer different classes of stock. This gives you more options than an S corporation, which is allowed to have only 100 shareholders and has restrictions on who can own shares.

Investors love a C-corp. Venture capitalists, even some angel investors, are willing to invest in a company only if they can secure preferred shares of stock, according to Laura Norris, director of the Entrepreneurs’ Law Clinic at the Santa Clara University School of Law. Indeed, many of them, if they are for-profit businesses or not based in the United States, can’t invest in S-corps, and many prefer not to wade into investing in LLCs.

Moreover, being a C-corp signals your company’s potential. It means your business is less constrained in its access to capital; it can tap equity investors to fund its growth. This comes into play, in particular, if you plan to take your business public.

Minimize health care costs. As the owner of a C-corp, you can deduct your health care insurance premiums from your taxes, and your business can fully deduct the amount on its corporate return.

C corporation: Cons

Double taxation of profits. Double taxation is a common reason many small-business owners choose not to set up as a C-corp. If your C-corp makes a profit, the IRS will tax it. Then, if you and other investors take a dividend, those proceeds are taxed again on your personal tax return and theirs. The government has effectively taken two bites of your apple, compared to the one it gets with businesses structured as pass-through entities.

Complexity. Owning and running a corporation in a legally compliant way is not a do-it-yourself project. There are federal and state filing and tax requirements to be met and “corporate formalities” to be observed, such as holding annual shareholder meetings.

To organize your business as a C corporation and keep it in line, you’ll need a lawyer and an accountant — perhaps teams of both — and they will cost you time, money and energy.

How to start a C corporation

• Pick a name for the company: Name your corporation, then do a thorough search of public databases in the state of incorporation and in any state in which you plan to do business. The website of the secretary of state’s office (or state equivalent agency) is a good place to start.

• Get an Employer Identification Number: If you don’t already have one, get an EIN. The IRS requires all corporations to have one.

• Name officers, a board of directors and draft a set of bylaws: This is a state requirement from the very inception of the corporation. New York, for example, requires new corporations to hold an organization meeting to elect a board and enact bylaws.

• Incorporate your business: You can register your business with different state agencies on the U.S. Small Business Administration website. Each state has its own forms, procedures and fees. For example, it costs about $100 to file articles of incorporation in California and about $125 in New York. The agency in charge of business entities could have different names. For example, in California, you’ll need to check with the secretary of state, while a similar office is called the Division of Corporations in Delaware.

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