Let’s go back to Corporate Taxation 101.
We were all taught that C-Corporations for small businesses were bad. They were taxable entities and to add insult to injury, if a shareholder took a dividend, they were taxed again on their personal tax return.
As a consequence, we were taught to form most companies using the S-Corporation tax election. S-Corporations are flow-through entities, whereby the corporation wasn’t taxed and the profits or losses flowed through to the shareholder to be claimed on their personal returns. Simple enough.
But in this article, I am here to change your mind about C-Corporations.
In an S-Corporation, a company faces different challenges. Reasonable compensation is one example. The fact is that a shareholder with more than 2 percent stock ownership cannot have employee benefits. And when the money passes through, depending on the nature of the shareholder’s tax situation, they can pay upwards of 39.6 percent in taxes. The point is, I know that as professionals we tend to give blanket answers. I used to be that way, but now I look at the situation as a whole.
In a C-Corporation you can approach the situation differently. For instance, you pay the shareholder a salary. With that salary, you can then have the shareholder pay themselves tax-free employee benefits. These benefits include a company car, medical reimbursement plan, health insurance, up to $5,150 in educational reimbursements, gym memberships, etc.
So, there are ways to get the money out of a C-Corporation without the double taxation. That’s not to mention that as part of the tax reform package that is floating around, C-Corporations will pay tax at a maximum rate of 20 percent as opposed to the 25 percent being suggested for those of pass-through entities.
Another reason to like C-Corporations is that they can have different classes of stock, which may not seem like a benefit until you are dealing with more than one shareholder or investors. To recap, there is common stock and preferred stock. Common stockholders have voting rights while preferred stockholders do not. In addition, you can give the shares different classes of stock, like Class A stock, which is usually for the founders of the company. Usually with Class A stock, the founders can have all of the voting rights plus they have complete control. Class B stock usually does not include voting rights and there is little or no control over the operations of the corporation. Some C-Corporations also have Class C shares, and even Class D shares. It all depends on certain things.
In a C-Corporation, you can start a business and classify the stock as IRC §1202 stock. This would allow a company to sell the shares of the corporation in five years from inception and exclude the first $10 million of the sale price from taxes.
The downside of a C-Corporation would be if the company owned any assets that would later be sold. C-Corporations do not benefit from capital gains tax. This is why most C-Corporations hold their assets outside of the corporation and in a holding company, for which the company rents the equipment from the holding company to the C-Corporation.
Further, after the salary and the tax-free employee benefits, if the shareholder does take a dividend, it’s not the end of the world. Qualified dividends are taxed at 15 percent.
C-Corporations are not meant for licensed professionals like attorneys, accountants, real estate agents or brokers, doctors, and any other company that can be considered as a professional service corporation (PSC). With a PSC, the corporation would be taxed at a flat 35 percent.
One example of a business that is perfect for a C-Corporation would be a company in the cannabis industry. In this market, you are running up against IRC §280E and because of the Federal prohibition on cannabis, the taxable income would be higher than most companies, because the taxes would be more than any normal company. You wouldn’t want the income to flow to the shareholders because the taxes would be more.
Other companies that are perfect for a C-Corporation structure would be IT companies that are either looking to sell out to another party, or those wanting to position themselves to go public. Just a note: those companies would want to be incorporated in a state like Delaware.
As you can see, a C-Corporation is no longer a death sentence. If safeguards are put into place, then there is no reason why you should automatically disregard them.