I had a conversation with an owner of a trucking company recently and when I asked them why they were structured as a C-Corp they really didn't know. They are are a small business with one owner who is involved in all the day to day operations and decision making. They take draws from the business and wages. The accounting and control processes aren't formally designed.
In most cases, I advise small business owners to not structure their business as a C Corporation. The main reason for this is the owner's need for the business to provide supplemental cash flow for their personal life. Another reason is that for most small business owners the executive structures compliant to running a C Corporation aren’t really what they are looking for.
C Corporations are designed for optimally capitalizing your business idea through shareholder equity. The corporation has a responsibility to the shareholders, and the structures and functions governing the business reflect that responsibility. There is a further level of detachment from the owner(s) distinct from sole proprietorships, partnerships, LLCs, and S Corporations. Whereas LLCs, Partnerships, and S Corporations have income that gets passed directly to the owner(s), a C Corporation is a being that retains its own income separate from the owner(s). The tax liability remains with the corporation.
What does this mean for the small business owner who wants to make a choice between a C-Corp and other entities? You really want to have an intention for how you want your business to relate your life, and for what you want the business to be in the world. For example, if you want to draw money from your business that isn’t in the form of a W-2 wage, a C-Corp most likely isn’t the structure for your business. If you want your business to be run by a CEO and board of directors so that operations don’t completely depend on you, and W-2 wages works for you, then you may want to consider the C-Corp.
Am I saying that the only income you can take from your C-Corp is W-2 wages? No. You can take dividend income from a C-Corp, and it may be optimal for you to take dividend income. The underlying consideration for C-Corps when it comes to you extracting an income from it, is double taxation. Double taxation occurs with this structure because the corporation is taxed on its net income, and you as the owner of the corporation will be taxed on any income you receive from it. The type of income your receive from the corporation is up to you. Just understand that each type is taxed differently, and dividend policies are proportionately universal to all shareholders of the same type of stock.
The C-Corp game can be an exciting and fulfilling one to play. You just want to understand the rules, so you have full access to choose as to whether you want to play and play it well if that is what you choose. There are complexities around executive governance, capital structure, and taxation that you will want to understand.
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For many small business owners, the simplicity of an LLC or S-Corp is optimal. They can take distributions from it more easily because the entity is passthrough, meaning the entity isn’t being taxed; only the owner(s). Many small business owners are tied to all functions of the business. They capitalize it with their own money or assets. They take out loans for it. They make the day-to-day decisions. They perform services. They hire and manage employees. The other entities are optimal for this. C-Corps, however, set the stage for the next level of business, where the owner can be removed from a high level of involvement and the business can be sustained on its own.
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Key Things to Consider When Thinking About a C-Corp Structure:
- Capitalization. Are you looking to raise capital through shareholder equity?
- Executive function. Are you looking to differ operational governance to a formal structure?
- Taxation. Are you okay with the double taxation? This doesn’t always mean you’ll be taxed more, but it often is the case.
- Formal processes for accessing income. You will have to determine how you will receive income from the C-Corp and always comply with this. Please note that you should be doing this with other entities as well. There are more compliance issues around this with a C-Corp because it is not a passthrough entity.
The benefit of a C-Corp is capitalization and growth through governing structures. It’s a good structure to build net worth if you don’t need to have access to all the profits from the business. You can let the retained earnings grow from year to year. It’s a structure that isn’t right for many small businesses. But you will want to understand what the structure was designed for, and what your specific goals are so you can determine if it’s the right structure for your business.