by Gary W. Smith

Choosing the right entity for your business isn’t easy.  In our first post, we listed questions you need to consider and the potential tax structures available to your business.  In this post, we will look at the second structure, C corporations.

First, the term “C corporation” refers to how the entity is taxed for income tax purposes.  The entity is just a corporation formed under state law.

When you decide to use a C corporation, you are making the choice to have the entity taxed separately from you as an individual.  This means you, as the owner, only pay income tax on compensation from the C corporation and dividends from the C corporation.  Otherwise, the C corporation pays income tax due from the business.  It’s important to note, C corporations only have one tax rate.  The terms “capital gains” and “ordinary income” don’t apply.

Why use a C corporation?  There are two potential reasons, in my opinion, why you would consider using a C corporation.  First, your individual income tax rate may be higher than the C corporation tax rate.  If you don’t intend to pull cash (or other property) from the C corporation as dividends, it may save you some income tax each year.

The second reason is a special tax benefit IF you sell your stock ownership of the C corporation when you exit.  If you meet the requirements for holding “Qualified Small Business Stock,” you could sell the stock in the future and pay no tax on the gain.  This is an attractive incentive, but you better be sure you won’t have to sell the assets instead of the stock when you exit.

Conversely, there are two big reasons, in my opinion, why you would not want to form a C corporation.  First, if you sell the business by transferring assets instead of transferring stock, you have two levels of income tax due.  The C corporation has to pay tax on the gain from the sale, and you have to pay tax on your dividends from the C corporation.  This is the “double tax” you may have heard about.

Second, C corporations only have one tax rate.  You don’t get to distinguish between capital gains and ordinary income.  This means you can end up paying a lot more in income taxes if you use a C corporation and sell the business by transferring assets.

For most privately-owned businesses, a C corporation isn’t the best option.  However, you need to consider this option because there may be something special about you or your business that makes a C corporation the way to go.

We are going to focus on S corporations in our next post.

Please feel free to send me an e-mail at [email protected] if you have a question about these options.

Gary Smith: Mergers and Acquisitions, Succession and Exit Planning, Securities and Capital Structures, Business Structures, and Tax attorneyGary W. Smith is an attorney at Venn Law Group with more than 20 years’ experience providing legal counsel and innovative solutions to business owners and management teams. His areas of focus include mergers and acquisitions, succession and exit planning, securities and capital structures, business structures, and tax. He excels at navigating the legal complexities of diverse industries ranging from professional services and IT infrastructure to manufacturing and real estate.