What is a C Corporation?

A C corporation is like a government…

The taxpayers of a particular city or state are like the shareholders of a corporation. They provide the funding and ultimately call the shots by electing the leaders. The taxpayers, like the shareholders, are legally separate from the organization. The politicians the people elect are like a corporation’s board of directors or executives — The people choose them to run the show, but they can oust them if they aren’t doing a good job.

A C corporation is a type of business that’s a separate legal entity from its owners. It can enter into contracts, make a profit, file tax returns, and be named in lawsuits. Because the owners are legally separate from the business, they aren’t liable (responsible) for its debts or financial obligations.

C corporations have a unique tax structure. They are usually subject to double taxation on the profits they distribute to owners. The company pays taxes on its earnings, and then owners pay taxes on those earnings again when they receive them as dividends.

There are many advantages to being a corporation, such as the limited liability of owners and the ability to raise capital by selling shares of stock. But double taxation and more onerous administrative and reporting rules create some extra hoops to jump through and can make corporations more expensive to form and maintain.

C corporations begin when founders file articles of incorporation and corporate bylaws with the government (typically the secretary of state) in the company’s home state. Articles of incorporation are a legal document that sets up a corporation and include important information, such as the company’s name, contact information, purpose, and the type of stock it plans to issue.

Once the C corporation is up and running, it can sell stock to shareholders, who become co-owners of the company. In return for their investment, shareholders often receive profits from the company in the form of dividends.

Though shareholders don’t always have a hands-on role in running the company, they do typically have some say. C corporations must hold an annual meeting of shareholders, where they can vote in a board of directors. The board is responsible for choosing executives, such as the chief executive officer (CEO), who run the company day to day.

One of the key features of C corporations is limited liability for shareholders. The company and the owners are separate legal entities. A C corporation can enter into contracts or be on the receiving end of lawsuits, and owners aren’t responsible for them.

Directors and officers of C corporations have a legal and ethical responsibility to shareholders to do their best to run a profitable company. One way that publicly traded corporations stay accountable is through the financial statements they must file with the Securities and Exchange Commission (SEC). These statements are:

• A balance sheet, which includes information about the corporation’s assets, liabilities, and shareholder equity
• An income statement, which reports the company’s revenue and expenses
• A cash flow statement, which reports on the cash flow coming into and going out of the company
• A statement of shareholders’ equity, or how much owners would receive if the company’s assets were liquidated and all debts repaid

One characteristic that defines C corporations is the way they pay taxes. Many business structures, such as sole proprietorships and limited liability companies, allow earnings to pass through to owners, who then pay taxes on them when filing their individual tax returns. C corporations are a bit more complicated in that the profits they distribute to owners are typically taxed twice. Because a C corporation is a separate legal entity, it must file its own tax return. The C corporation claims its corporate income, losses, deductions, and credits. Then the company pays corporate taxes on the profits at a flat rate of 21%.

Once the C corporation has paid taxes, it can choose to give out some of the remaining profits to shareholders in the form of dividends. Shareholders then have to pay income taxes on those dividends. As a result, those earnings are taxed twice.

Suppose that a C corporation has an annual profit (meaning business income minus expenses) of $100,000. With a corporate tax rate of 21%, the company pays $21,000 in taxes. The corporation has $79,000 left. If it has five equal owners, each could receive $15,800 in profits, unless the company chooses to retain those earnings. Each owner would then claim that income on their individual tax return and pay income taxes on that amount.

A C corporation is a business entity that is entirely separate from its owners legally. This setup allows business owners to shield themselves from the liabilities (debts or other financial responsibilities) of the company. C corporations can sell shares of the company in the form of stock, which allows new owners to join the company.

An S corporation is a different type of corporation that involves pass-through taxation. C corporations are usually subject to double taxation — They must pay corporate taxes on earnings before giving out profits to owners. An S corporation can skip the corporate taxes and just pass the profits and losses along to owners. But keep in mind that S corporations may still have to pay taxes on certain gains and passive income.

Choosing to pay taxes as an S corporation has its advantages, but it can also have downsides for owners. When a company is an S corporation, shareholders claim their share of the company’s profits and losses on their personal income tax returns. But the company doesn’t have to give out all the profits. As a result, shareholders may end up paying income taxes on money they never received.

There are also specific criteria a company has to meet to get S corporation status. The corporation must:

• Be an eligible corporation (which excludes certain financial institutions and insurance companies, among others)
• Be based in the US
• Have fewer than 100 shareholders made up only of individuals (who must be US residents), certain trusts, and estates
• Have just one class of stock

To qualify as an S corporation, all shareholders have to agree to the status. Each shareholder has to sign a form filed with the Internal Revenue Service.

One corporate status isn’t necessarily better than the other. There are specific rules to become an S corporation, and many C corporations don’t meet those requirements. For those that do, S corporations may have financial benefits in certain situations.

A limited liability company (LLC) is another business structure that allows owners to separate themselves from the company’s liabilities. That means their personal assets (like a car or house) aren’t up for grabs in a lawsuit or bankruptcy. Compared to a C corporation, LLCs can be more advantageous for small business owners who don’t plan to take their companies public, as an LLC doesn’t allow a company to sell shares.

LLCs are a simpler business structure that lacks some of the rules that C corporations have to abide by. In many states, they don’t have to hold annual shareholder meetings, since there are no shareholders. They also don’t have to file the extensive financial statements that C corporations do.

LLCs come with some financial benefits that C corporations don’t have. First, LLCs have pass-through taxation, which means that the company doesn’t pay corporate taxes (though a handful of states impose franchise taxes on LLCs). The company’s profits and losses pass through to the owners, who then claim them on their personal income taxes. As a result, LLCs are able to avoid the double taxation and the 21% corporate tax rate that C corporations are subject to.

LLCs can also choose to be taxed as an S corporation, which allows them to keep the tax benefits of an LLC while potentially lowering their tax burden. In this situation, the LLC owner pays themselves a salary. The owner pays self-employment taxes on that salary, which are the payroll taxes that employees and employers normally split the cost of in a traditional employment relationship.

Then, the owner can distribute the rest of the LLC’s earnings to themselves without having to pay self-employment taxes on those profits. These earnings are subject to pass-through taxation, meaning the business doesn’t pay taxes on them, but owners must claim them on their personal income tax returns.

The owner of an LLC taxed as an S Corporation can’t choose to only pay themselves in distributions, rather than a salary, to avoid self-employment taxes. The Internal Revenue Service requires that this entity pay the owner reasonable compensation based on their activities, level of training and experience, and other factors.

C corporations are one of the most complicated types of business structures that a company can choose. While there are advantages to choosing this structure, there are downsides as well.

Advantages:

• C corporations are legally separate entities, which means the owners aren’t responsible for the liabilities of the business.
• They may be able to raise capital more quickly than some other types of businesses because they can sell stock shares.
• C corporations aren’t dependent on the actions of a shareholder. If a single shareholder decides to sell their stock and separate from the company, the corporation can continue to do business.
• They can be an advantageous business structure for companies that plan to go public.

Disadvantages:

• Both C corporations and their owners must pay taxes on earnings, which reduces the profit left over for owners.
• Because of the accountability C corporations have to their shareholders, they face added reporting, meeting, and administrative rules.
• C corporations are typically more costly to set up and maintain than other business structures.

Each year, Fortune compiles a list of the top 500 corporations in the US. The magazine bases its rankings on the companies’ revenues, profits, balance sheet, number of employees, earnings per share, and other criteria. The list does not constitute a recommendation to buy, sell, or hold any security.