Big American companies like Microsoft and Walmart are C corporations—that is, their income is taxed under Subchapter C of the US Internal Revenue Code. But many of the benefits enjoyed by large, multinational business entities can be effectively leveraged by a small business owner too, especially those who want to garner investment in their business by issuing stock.
What is a C corp?
A C corp is a business structure in which owners (or shareholders) are taxed separately from the entity. Shareholders are owners of the corporation, each having a fractional interest in the whole. A shareholder could own a single share of the company, or millions of shares. C corps raise funding through the sale of these shares.
The C corp entity itself is subject to corporate income taxation, while shareholders are subject to personal taxation. In simplest terms, a C corp pays tax on its income just as an individual would pay tax on their yearly salary—a flat 21% on operational profits. Because shareholders in a C corp are legally distinct from the corporation itself, profits distributed to shareholders in the form of dividends or other distributions are taxed at shareholders’ personal rates—resulting in something called “double taxation.”
C corps are considered the default corporation type. When you file articles of incorporation in your state of choice, the state will recognize your new corporation as a C corp by default.
Alternatives to C corps include: S corporations (S corps), and limited liability companies (LLCs). To register an S Corp, you must file Form 2553 and ensure S corp formation requirements are met. All three types divide a company’s assets from those of ownership, but are taxed differently.
When to form a C corp
Your business has to operate as a C corp if:
- You want to issue stock to more than 100 shareholders.
- You want to issue stock to international investors or other corporations.
- You want to issue both common and preferred stock. Common stock comes with voting privileges; preferred stock comes with no voting privileges, but preferred stockholders jump the line in terms of priority when it comes to receiving dividends, or payouts if a company is liquidated.
How to form a C corp
Forming a C corp is a complex process that likely will require consulting with a tax professional and a lawyer. At a high level, the steps for forming a C corp are as follows:
- Register a unique business name.
- Appoint officers to the corporation (CEO, board of directors).
- Draft and file articles of incorporation with the secretary of state in your state. There may be financial benefits to filing in some states over others, i.e., a state where the corporate tax rate is lower.
- Write company bylaws.
- Issue stock—literally. Blank paper share certificates can be purchased at office supply stores or online. These certificates indicate the percentage of the corporation the holder owns. The number of shareholders is important here—C corps with fewer than 35 do not need to register shares with the US Securities and Exchange Commission.
- Apply for a business license at the state, county, and municipal levels.
- File a Form SS-4 to obtain an employer identification number (EIN) from the IRS.
- Apply for any other ID numbers required by state and local governments, such as for unemployment and disability insurance.
What to know about operating as a C corp
Running your small business as a C corp will be more complex than doing so as an LLC, for example. There are substantially more rules and regulations to follow. But the complexity is a necessity for businesses with more than 100 shareholders, or those that plan to seek investment from international sources or other corporations. Here’s what’s involved in operating as a C corp:
- Annual meetings. A C corp is required to hold at least one annual meeting for shareholders and board directors.
- Detailed record keeping. Minutes for these meetings must be recorded in accordance with corporate transparency laws. A C corp must also keep records of votes of its board of directors and a comprehensive list of owners’ names (shareholders), along with ownership percentages. Company bylaws must be kept at the primary business location as well.
- Up-to-date reporting. C corps must file annual reports, financial disclosures, and financial statements, for the interests of shareholders and prospective shareholders.
Pros and cons of C corps
Choosing to form as an C corp can offer structural advantages not available to S corps and LLCs: freely transferable interests, a sky’s-the-limit funding apparatus, and an undeniable sheen of legitimacy, which can attract investors.
Benefits of forming and operating as a C corp
- Limited legal and financial liability for owners.
- Ease of access to funding by selling stock—as much as you like!
- Shares are freely transferable.
- More attractive option to investors looking for passive income.
- Ability to reinvest in the business at the corporate tax rate rather than at the owner’s personal income tax rate (as is the case for S corps and LLCs).
- A general perception of legitimacy—companies that sell shares are subject to a lot of regulations that give investors confidence in the solidity of the business.
Drawbacks of forming and operating as a C corp
- Expensive to form compared with other structures, like LLCs or sole proprietorships, due to the level of legal complexity, which will likely involve hiring a tax professional and one (or more) lawyers.
- Complicated operation.
- Double taxation.
How to convert an LLC into a C corp
A business owner may want to convert their LLC into a C corp if they seek outside investment or want to issue shares of their company. There are two main ways to convert an LLC into a C corp—statutory conversion and statutory merger. The method taken will depend on state laws where an LLC is registered.
A statutory conversion is the quickest and easiest of the three conversion methods. You can transfer the LLC’s assets and liabilities to a C corp without having to dissolve the LLC altogether. The LLC’s former members become corporate shareholders. The general process entails the following:
- Create a plan for conversion and get approval from members. This is a relatively simple statement of key points in the conversion. At a minimum, it usually includes all identifying information for your current and new business entity, a statement indicating an intent to continue operations under the new entity, and anything else required by your state’s secretary of state office.
- File a certificate of conversion with the secretary of state and pay a filing fee.
- File relevant documents as required by your state in forming a C corp.
A statutory merger is more complicated but can be a viable option if your state does not allow statutory conversions or your specific entity type. (For example, New York is one of 10 states that does not permit statutory conversions of corporations to LLCs—check with your state’s secretary of state office to ascertain what is allowed where you intend to conduct business.)
Under a statutory merger, you must form a new corporation with LLC members as shareholders, then merge the two companies and formally dissolve the LLC. The process entails the following:
- Form a separate C corp with LLC members as shareholders.
- Create a merger plan in accordance with your state’s merger laws (a “Plan of Merger,” as it is often known, is a simple template document, usually drawn up by an attorney familiar with the merger and acquisition laws of your state). This plan must be approved by all members.
- Exchange LLC interests for shares in the new C corp.
- File a certificate of merger with the secretary of state.
- File for dissolution of the LLC with the secretary of state.
If you aim to convert an S corp to a C corp, the IRS does not offer a standard form for shifting tax status. Instead, you can simply file a written statement with the IRS, along with a consent form signed by a majority of corporate shareholders.
How do C corps compare to other entity types?
C corp vs. S corp
The main difference between a C corp and S corp lies in tax treatment. A C corp pays taxes on all corporate income, and shareholders pay personal taxes on any income they receive as dividends. S corps have pass-through taxation—shareholders report business income and losses on their personal tax return, but the company does not pay corporate tax. S corps are also limited to a maximum of 100 shareholders, who all must be US citizens or permanent residents.
S corps also require special documentation to be filed with the IRS, whereas C corps are generally recognized as the default corporate structure in most states.
C corp vs. LLC
Unlike C corps, LLCs are owned by a single owner or a group of owners. LLCs can’t issue shares, so there are no obligations to shareholders. Instead, LLCs are composed of members who share in company profits. LLC members can choose how to be taxed: they can opt into pass-through status, like S corps, or be subject to double taxation, like C corps. They can also be taxed as sole proprietorships or partnerships for simplicity’s sake.
Forming and running your small business like major US corporations can, at first, seem like a daunting undertaking, with tangled corporate regulations, checklists, and deadlines.
The chief benefit of forming a C corp is selling an unlimited number of shares. It’s a built-in funding method that can be crucial to any early-stage small business. The C corp is not just an option for the Bill Gateses and Mary Barras of the world—it could be just what your small business needs to flourish.