What is a C Corporation? [Full Breakdown]
When forming a small business, you have several different options for what kind of legal entity you want your company to take. One of those options is a C corporation.
A C corporation is a business entity that offers strong liability protection and the ability to bring on lots of shareholders — an important thing for businesses that are looking to bring in outside investment.
For many business owners, however, a C corporation’s lengthy and expensive incorporation process may be more trouble than it’s worth. In this article, we’ll dive into C corps, learning how to form them, what they’re good for, and how they compare with other business entity types.
What is a C Corporation?
C corporations are businesses owned by shareholders. This can be a few shareholders, in the instance of a small business, or thousands of shareholders, in the case of a large company.
When it comes to legal or financial liability, the company is held responsible for debts or lawsuits, not the individual shareholders. It is a separate entity, which offers serious protections for people who own the business.
Unlike other business entities, however, C corporations have to pay their own taxes. They can’t “pass through” earnings to business owners, who then process the taxes on their personal IRS tax returns. In the United States, C corporations also have to file an annual report of share performance and corporate income, per federal law.
Deciding if a C Corporation Is Right for You
A C corporation offers protection for business owners and makes it easier to grow aggressively. However, it’s onerous and expensive to set up (more on this in the next section), and it requires owners to file corporate tax returns, which can have a higher tax rate.
If you are starting a small business, the C corp business structure makes sense if:
- You plan to go public in the future, so you’ll be set up to take on shareholders
- You want to raise a lot of money from outside investors
- Your business has extensive liability (think heavy construction or healthcare) and you want to protect your personal assets
One of the main advantages of a C corporation is that it’s set up, from the start, to bring on many different shareholders. You can set up shareholder classes, divvy up the company as you see fit, and accept investment without slowing down growth. If you ever want to take the company public, you’re already prepared to do so.
A C corp also offers an extra layer of liability protection. If something disastrous were to happen or the company were to be sued, a C corp owner can’t have their personal assets seized.
Note: There are other business structures which offer liability protection and may not require the level of setup a C corp needs, which we’ll discuss below in the section on LLCs and S corporations.
Creating a C Corporation
Before we get started, you should know: You will almost certainly need a lawyer to create a C corporation. There are online legal services that will help you form one, but wherever you go, you’ll need a lawyer. There are several corporate formalities to be taken care of before a C corp can be formed.
Here are the steps to form a C corporation.
1. Learn Your State’s Rules on C Corps
Every state has slightly different rules and fees when it comes to forming a C corporation. If you visit the website of the secretary of state for your home state, you will be able to learn about filing fees and what steps you need to take to form a corporation.
2. File Articles of Incorporation
This is your official declaration to your state that you are forming a corporation. This certificate of incorporation is usually filed with your state’s registrar or its secretary of state office.
3. Create Bylaws
Your bylaws will be a list of internal rules that your company will abide by. They should be detailed and specify the internal management structure of your company as well as how you plan to run the company. These bylaws will be voted on and adopted by your company’s board of directors after incorporation. Many lawyers also recommend you create a founders’ agreement, which will set out rules and prevent disputes among the initial business owners.
4. Name a Board of Directors
Your board of directors will act on behalf of your shareholders when it comes to how the company is managed and run. Directors hold regular meetings to discuss how the company is being managed, where to invest capital, and more. There will also be annual meetings to discuss the state of the company, which will then be passed along to shareholders.
Is your company just one person? Most states allow one-person corporations, where you would be the officer, director of the board, and shareholder. (If you’re just a one-person business, however, there might be better business structures to set up, which we’ll get to in the next section.)
5. Issue Stock Certificates to Initial Shareholders
These are official documents which show shareholders that they own a piece of the company. You’ve now got shareholders, a board, and an incorporated company. You’re ready to do business.
C Corporation vs. LLC vs. S Corporation
You have options when you start a new business. For small-scale businesses with only one or two employees, it might be simpler to form a sole proprietorship or general partnership. These business types require little to no paperwork to set up (often just registering as a business with your state). Owners can set up the business and divide control as they see fit, and taxes on the business are able to just pass through to your personal income tax returns, simplifying the entire tax process. The downside? No liability protection, as your personal liability and business liability are not legally separated.
This is what makes C corporations, LLCs, and S Corporations popular for business owners who want protection. Let’s get to the pros and cons of each.
LLC, or limited liability company, is a simple business structure that offers you protection from personal liability by forming a business that is a separate legal entity from the owner. It’s much simpler and less expensive to set up than a C corporation and has tax advantages, like pass-through taxation.
The biggest downside of an LLC is that it’s more complicated to bring on additional shareholders, which can make raising money more difficult. It also offers limited liability protection, which might not be as strong as the protection you get from a C corp.
An S corporation also offers excellent liability protection and allows for taxes to pass through to the owners’ personal tax returns.
The biggest downside to an S Corporation is that it limits growth. Getting S corporation status means you have to abide by several rules: You are not allowed to bring on more than 100 shareholders, and all the shareholders must be U.S. citizens. It can also be a bit more challenging to set up than an LLC.
We’ve already covered a lot of the advantages of forming a C corporation: liability protection, ability to raise money through additional shareholders, etc.
The biggest downside with C corps are the costs associated with setup and taxes. C corps have to file corporate tax returns, which, if you’re a small business, means that you’ll effectively be getting double taxation. You’ll have to pay taxes on your company’s earnings and on whatever salary you give yourself. C corporations do allow you some tax breaks for businesses that aren’t making money, but if you’re just starting out, the taxes can be tough.
Is a C Corporation Right For Your Small Business?
When evaluating what kind of business structure you want for your company, it’s important to understand the options available to you. A C corporation can be expensive and onerous to set up, but if you have grand designs for your company and believe in its growth, no legal entity is better set up for rapid expansion. With strong liability protection and the ability to issue stock to many different shareholders, a C corporation is a good choice for business owners who want to start a company that’s ready to scale in a big way.