Most people who set up a new business select a basic LLC structure or opt for an S-Corp. These entities are rather common and work for most small businesses. But many people don’t understand the C-Corp advantages.
But many business owners fail to consider C corporation. Even though this ownership structure has always been an option for small businesses, it just needed to make more sense. But now that may have changed.
Before setting up a business entity (or converting your existing one), consider why a C corporation may make sense for your next venture.
Starting and growing a successful business requires careful consideration of various factors, including the legal structure chosen for the enterprise. One popular option for entrepreneurs is a C-Corporation, a business structure known for its flexibility, scalability, and significant advantages. In this article, we will explore the benefits of forming a C-Corporation and why it is an attractive choice for many ambitious business owners.
- Limited Liability Protection One of the primary advantages of a C-Corporation is the limited liability protection it offers to its owners. In this structure, the corporation is considered a separate legal entity, distinct from its shareholders. Consequently, the personal assets of shareholders are shielded from the debts and liabilities incurred by the corporation. This separation ensures that business-related risks do not impact personal finances, providing individuals with peace of mind and a higher degree of security.
- Access to Capital C-Corporations have a distinct advantage when it comes to raising capital. Unlike other business structures, such as sole proprietorships or partnerships, C-Corporations can issue multiple classes of stock, including common and preferred shares, enabling them to attract investors more easily. This flexibility in equity offerings allows corporations to raise substantial funds for expansion, acquisitions, research and development, or any other strategic initiatives, thus fueling growth opportunities that might otherwise be challenging to pursue.
- Perpetual Existence Unlike sole proprietorships or partnerships, a C-Corporation has a perpetual existence. The corporation continues to exist even if there are changes in ownership, leadership, or the death of individual shareholders. This attribute grants the business stability, continuity, and the ability to outlive its founders, making it an attractive choice for long-term ventures and businesses seeking generational continuity. There are many C-Corp advantages.
- Tax Flexibility While taxes can be complex, C-Corporations enjoy certain tax advantages. For instance, corporations have the option to deduct employee benefits such as health insurance, retirement plans, and fringe benefits, which can be highly attractive to both employees and the business itself. Additionally, C-Corporations can retain earnings and be taxed at the corporate level, which can lead to potential tax savings for shareholders who are not required to report profits until dividends are received. This advantageous tax treatment allows corporations to reinvest funds into the business for expansion or other strategic purposes.
- Employee Benefits and Stock Incentives C-Corporations have the ability to offer a range of attractive employee benefits and stock incentive plans. This includes stock options, restricted stock units (RSUs), and employee stock purchase plans (ESPPs). By providing these incentives, corporations can attract and retain top talent, aligning employee interests with the success of the company. Such programs not only boost employee morale and loyalty but also provide employees with the opportunity to share in the financial success of the corporation, creating a sense of ownership and motivation.
- Enhanced Credibility and Prestige Opting for a C-Corporation structure can enhance a company’s credibility and prestige in the business world. For investors, lenders, and potential business partners, a C-Corporation signifies a commitment to a structured and organized approach to business operations. It can also help establish trust and confidence among suppliers and customers, as the legal framework and stringent regulatory requirements associated with C-Corporations provide an added layer of assurance and transparency.
Lower business tax rate
Before tax reform, the first $50,000 of C corporation profits were taxed at only 15 percent, with the highest rate being 35 percent. But now rates have been lowered to 21 percent for all business income, far lower than the highest personal tax rate of 37 percent.
Even though the rate has been reduced, shareholders are still taxed 15 percent on paid dividends. So C corporations still have double taxation. But at least you have control over when you issue a dividend.
Shifting dollars to a C corporation can move income away from your tax return, thus allowing for lower adjusted gross income (AGI). The benefits of lower AGI are that it may limit the phase-out of various deductions and credits. These phase-outs include (among other things) education credits, child tax credits, and rental property passive losses.
Fringe benefit options
For C corporations, fringe benefits are tax deductible for the company and tax-free to the shareholder-employee. Examples include health insurance, medical or health care reimbursement plans, travel, education, and group term-life insurance.
I have clients who incur substantial medical expenses and have used medical reimbursement plans to their benefit. I prefer these medical plans to Health Savings Accounts because of the flexibility and liberal spending limits. This is one of my favorite C-Corp advantages.
Capital gain exclusion
The sale of particular qualifying C corporation stock is afforded a capital gains exclusion. This little-known provision falls under Section 1202 of the Internal Revenue Code.
Assuming the shares qualify, the capital gain exclusion ranges from 50 percent to 100 percent of the gain. The qualifications can be complex, so you should discuss the structure with the appropriate tax and legal professionals. But if a company is being established to be sold at some point in the future, Section 1202 can be a game-changer.
Flexible ownership structure
While partnerships offer a very flexible ownership structure, S corporations have numerous ownership rules that restrict: (1) more than 100 shareholders; (2) non-resident alien shareholders; and (3) non-individual shareholders (with a few exceptions). C corporations do not have such restrictions as they allow for unlimited shareholders and shareholder types. This makes them great for entities with many owners.
In addition, since partnerships and S corporations are pass-throughs, they will issue a Schedule K-1 to the business owners. These K-1s include the owner’s allocated share of any income or loss from the business entity. These amounts must be reported on the investor’s income tax return.
But for passive investors, these K-1s can be a nuisance and can hold up their tax filing. Additionally, due to passive loss rules, investors will typically be unable to claim any losses on their tax returns.
While it is true that there are many benefits to pass-through entities, they are certainly not the best entity structure for all business owners. So rather than selecting a pass-through for your next business, look closely at a C corporation. Thanks to tax reform, it may be your best option.
Final thoughts on C-Corp advantages
Choosing the right legal structure is a critical decision for any business owner, and a C-Corporation offers a host of advantages.