A corporation is a business structure formed in compliance with state law, with the purpose of operating for profit. Corporations can enter into contracts, own assets, sue and be sued, borrow money from financial institutions, and pay state and federal taxes. Many common types of corporations have their own federal tax implications as well.
Different forms of corporations serve various purposes, and there are benefits and drawbacks to each. These differences can determine which—if any—corporation suits you and your business goals.
Most businesses use a C corporation structure. Learn all about how C corporations work, their pros and cons, and alternative corporation types.
Definition and Examples of a C Corporation
A C corporation is the standard type of corporation in the U.S., and it’s probably the one most people think of when they hear the term. It’s a separate legal and taxpaying entity from its owners. A C corporation can:
- Buy, sell, and own property in its own name
- Enter into contracts and incur its own debts that the owners aren’t responsible for
- Be liable for wrongdoing, so it can be sued and can also sue when it’s been wronged
A C corporation often has more than one owner, referred to as a shareholder, but it can have just one, as well. These are individuals or other companies who effectively buy into ownership of the corporation by buying shares of the business. Despite that, they are still separate entities from the business, so these individuals generally cannot be sued or be at risk for actions taken by the company.
A corporation is legally independent of the owners, so in the case of a problem or a lawsuit, the shareholders, directors, and officers cannot be held personally liable. There is still a possibility, though, that the owner can become personally liable with their assets.
Let’s say that Bob and Sue want to go into business together. They form a C corporation. Various friends and family members support their idea to the extent that they buy shares in the business, raising capital to fund its operation. All told, including Bob and Sue, there are 10 shareholders.
Over time, the business incurs $1 million in debt and goes under. Bob, Sue, and the other shareholders aren’t personally responsible for repaying that money. Sue can have a change of heart and sell her share of ownership to someone else, if possible. Or she might die, in which case her shares are passed to her heirs. The C corporation goes on.
A C corporation has to report to its charter, which varies by state. Actions that are taken by a C corporation, and actions they’re prohibited from taking, are determined by its charter. There are also varying tax implications, depending on the state where the corporation is registered.
- Alternate Name: C corp
How a C Corporation Works
Ownership of a C corporation is determined by how many shares each shareholder holds. Each shareholder is a partial owner of the business. If Bill purchased 40 out of 100 shares of Bob and Sue’s corporation, Bill would own 40% of the corporation.
But Bill probably won’t run the operation. He’s just an investor. The investors/shareholders will collectively elect a board of directors to manage the business. The board of directors can sell additional shares of the business. It might do this if it needs to raise capital for a new venture or expansion, for example.
The shareholders receive income in exchange for their buy-in. They’ll receive dividends as a percentage of the corporation’s profits—what’s left after operating and business expenses are deducted from its gross earnings—based on how many shares they hold.
When it comes to the tax process, personal tax liabilities are not connected to the losses of the company at hand. Income earned through business practices is taxed. Once this occurs, the owners make money.
Corporations are double taxed: First, through initial income, and then again when the funds are filtered to the owners. This can have an impact on shareholders, potentially deterring them from remaining with the company, so it’s important to fully understand the tax implications prior to getting involved with a corporation.
Pros and Cons of C Corporations
- C corporations are separate legal entities
- They can raise capital when necessary by selling more shares
- C corporations are subject to double taxation
- The corporate tax rate is expected to increase under President Joe Biden
- C Corporations are separate legal entities: The primary benefit of a C corporation is the insulation it provides to shareholders, shielding them from any liability for the corporation’s actions or debts and vice versa.
- They can raise capital when necessary by selling more shares: If a corporation is in a tight spot, it is relatively easy for them to sell more shares and raise capital. They often have an easier time borrowing money than other corporations because of this, as lending institutions know C corporations can raise additional income in a pinch and pay off their debts.
- C corps are often subject to double taxation: First, the corporation pays taxes on its profits, and then it distributes dividends to shareholders from those profits. The shareholders must also report these shares of income on their personal tax returns. The corporation doesn’t get a tax deduction for dividends paid to shareholders, and shareholders can’t deduct any of the corporation’s operating expenses or other costs of doing business.
- The corporate tax rate is expected to increase under President Joe Biden: The U.S. corporate tax rate is high—21% since the enactment of the Tax Cuts and Jobs Act (TCJA) in 2017—and it might just get higher. President Joe Biden has indicated a desire to increase the rate to 28% during his term.
Other Types of Corporations
Although the term “corporation” usually refers to C corporations, there are other forms of this business structure, as well.
An S corporation is one that has made an election with the IRS to be taxed differently than a C corporation. The S corporation itself isn’t taxed. Profits—and losses, as well—trickle down and pass through to shareholders, who must then report them on their own personal tax returns. This allows corporations to avoid being taxed twice.
An S corporation must:
- Have no foreign owners
- Be a U.S. corporation
- Have no more than 100 approved shareholders
- Issue only one class of stock
Sometimes referred to as 501(c)(3) corporations per the Internal Revenue Code that provides for them, these entities aren’t in the business of passing profits on to their shareholders. Rather, they use the money to further one or more social causes. They’re typically formed by religious, charitable, and educational organizations rather than individuals.
Nonprofit corporations are tax-exempt at both the federal and state levels. Their profits aren’t taxed and members aren’t permitted to receive any compensation. These corporations must register with the IRS to receive this exclusion.
Sometimes called a benefit corporation, B corporations are something of a hybrid between C corps and nonprofit enterprises. They support various public benefits, but they additionally pay out to their shareholders. States can require these corporations to submit annual reports to prove that they are indeed furthering their chosen cause, and to what extent.
Requirements for a Corporation
Forming any type of corporation is not something you’d want to go through without professional guidance. The correct documentation and legal structuring are critical to reaching your goals.
To form a C corporation, you must file articles of incorporation with your state according to its particular regulations, which can vary slightly from jurisdiction to jurisdiction. Bylaws and a charter must be drafted as well, and stock must be issued, even if a C corp has just one shareholder.
Before starting or leaving a corporation, be sure to consult with a financial professional to fully understand the processes and duties involved.
Leaving a C corporation is also complicated. If you determine the company is not meeting your needs, you need to go through a process to separate yourself from the corporation. You’ll need a liquidator—someone who’s assigned to sell assets and satisfy the business’ outstanding debts from the proceeds. Shareholders would only receive shares of any funds that are left over.
- A corporation is a separate legal entity from its owners/shareholders. It shields its shareholders from its debts, obligations, and liabilities.
- C corporations’ profits are taxed twice—once at the corporate level and again when dividends are paid out to shareholders from their net profits.
- An S corporation’s profits and losses are passed down to shareholders to report on their personal tax returns.
- Nonprofit corporations that serve the public good are tax-exempt if they meet certain qualifications.