Things have been moving along nicely with your business. Perhaps it started as a sole proprietorship and then you brought on another partner and decided to expand to a Limited Liability Company (LLC).
But at some point, you decide that the time is right to incorporate your business. This is known as forming a C-Corp, which gets its name because it is governed by the Subchapter C of the Internal Revenue Code.
The majority of the big businesses out there are structured as C-Corporations. There are a multitude of reasons why you might want to form a C-Corporation, but the two that often times jump out are because of 1) taxes and 2) the desire to raise venture capital.
Fred Wilson explains it perfectly in his blog post about corporate entity: “The flow through of taxes in the LLC can cause venture funds and their investors all sorts of tax issues. This is particularly true of venture funds with foreign investors.”
The reality is this: if outside investment is going to come in, you’re going to want to upgrade your LLC to a C-Corporation. That being said, there are other types of corporations, such as S-Corporations and B-Corporations, that get thrown around. We’ll cover those in future posts.
Once you get above a sole proprietorship, the requirements for forming any sort of corporate entity are relatively straightforward. One of the primary differences between forming a C-Corporation and a LLC is that you don’t need to publish any announcement in a newspaper, often saving hundreds, if not thousands, of dollars.
The first step is determining the name of your corporation. More often than not, the state that you register will require that you end the business name with a designation such as Corporation, Incorporated, Limited, or some variation of that.
The next step is to file your Articles of Incorporation with the state’s Secretary of State. In this document, you’ll need to list the names and addresses of all the initial officers and directors. In other words, if you have initial shareholders, you’ll need to list them in this document. For an example on what an articles of incorporation looks like, read over what Yahoo’s looked like.
Once the articles of incorporation have been accepted and filed by the Secretary of State, you will then issue the stock certificates to all the initial shareholders. In Yahoo’s example, they had 235 million shares to split among the shareholders. At the time that the document was filed, those shares were worth $157,450.
Now that you’ve got your corporation, you need to ensure you’re squared away with the IRS. To do this, file a Form SS-4, which is a corporation’s way to get an Employer Identification Number (EIN). Even if you’re never going to hire a single employee, you still need this because this is how the IRS recognizes your business when it comes time for you to pay taxes.
There are five different kinds of tax forms you'll need to fill out for a C-Corporation.
Finally, ensure that you have all your state requirements. This might be business licenses and permits for the industry. It might also be any local ID numbers mandated by your state and local government. Often times, an attorney or local accountant will have all the information on what you’ll need to have your business compliant.
Taxes for a C-Corporation can actually be relatively straight forward. Unlike with a LLC and a sole proprietorship, where you have to distribute K1s and have the individual members file their respective taxes, a C-Corporation has its own tax documents. The forms are:
Form 1120: U.S. Corporation Income Tax Return. This includes all revenues and losses.
Form 1120-W: Estimated Tax for Corporations. A Corporation has to be pay quarterly taxes, which is your way of estimating how much you’ll make.
Form 941: Employer’s quarterly federal tax return. When you withhold taxes from your employees, you need to send it to the government. This is the form you file at the end of the quarter to explain how much you sent.
Form 940: Employer’s Annual Federal Unemployment (FUTA) Tax Return: This is a rundown on how much you’ve paid in unemployment taxes in your state.
Form 1099-DIV: Dividends and Distributions: This form lays out what each shareholder received in dividends and distributions.
There can be many more documents that you have to file depending on which state you’re in, but these are the primary ones as a corporation. The tax rate for corporations is approximately 39.1%, but it can drop considerably depending on deductions and other exclusions.
The very first advantage has to do with the number of shareholders a C-Corporation can have. Unlike the S-Corporation, which can only have 100, a C-Corp can keep adding shareholders. In the example of Yahoo, it could have, theoretically, brought on one shareholder for every share of stock that it had.
The ability to has unlimited shareholders means that it is the preferred mechanism for venture capitalists. If you’re looking to raise money, there is no corporate entity more attractive for a VC.
Another benefit is that many things become a deductible expense. For example, accident, health, and life insurance are all deductible. The salaries of all employees—including yourself—are also deductible. This helps to significantly drop how much money the company has to pay in taxes, a luxury that many individuals don’t have.
On the topic of taxes, because the C-Corporation is its own entity, the founder doesn’t have to pay taxes on what the corporation earns. The corporation is taxed at its own rate and the individual is taxed at his/her income rate if there are dividends distributed.
That divide between what the corporation has to pay taxes on and what the individual pays taxes on can also be a disadvantage. Consider that with a LLC and a sole proprietorship, the income flows to the individual who then pays their taxes. With a C-Corporation, the business pays income taxes and then the individual pays income taxes on any dividends distributed: this is double taxation.
For example: If the business makes $1 million in profit and after deductions, the business has a tax rate of 20%, the business is left with $800,000 in the bank having sent $200,000 to the government. It decides to distribute that $800,000 to each of the four founders in equal chunks. Each of the four founders receives $200,000, but they are then taxed at their own income tax rate. That $1 million gets taxed twice.
Another disadvantage is that it can take a lot of time to run a C-Corporation. You are required to hold formal board and shareholder meetings and need to have accurate minutes of these meetings. This added paperwork can often times take away from running the business.
There are many reasons that you might want to set up a C-Corporation, but there are three questions to ask that will help you determine if it’s right for you:
Will I hire employees? You want the limited liability that comes from running a corporation. This protects you and it protects your employees to some extent.
Do I need to fundraise? If you are a tech company-or any company really—looking to raise venture capital, you’ll need to be a C-Corp.
Do I want to save money to expand? Other corporate entities pass all earnings to the individual for taxes. Since a corporation gets taxed separately, it can hold onto its profits to invest in the future.
Running a corporation can be a lot of work. Fortunately, Justworks can help with some of the process. When it comes to submitting employee documents, Justworks is the platform many trust to get it all right.
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