C Corporations are Taxed as a Pass Through Entity

C corporations are taxed as a pass through entity, meaning that, if any profits of the corporation are distributed to its shareholders in the form of dividends, then those shareholders must pay personal income tax on such dividends. Therefore, while it does ‘pass through’ in a sense, the C corporation is still double taxed – once at the corporate level and then again at the personal level.

When a business incorporates, it can choose to operate as either a C or S corporation. There are many benefits to both, as well as some disadvantages. It is important to ensure that you understand all of your rights and responsibilities in operating each type of business structure before choosing which type of corporation to operate.

Overall, many business structures do actually operate as flow-through entities because the business itself is not required to pay corporate income tax. For example, for sole proprietorships, partnerships, and S corporations, the business profits and losses flow to the owners and shareholders. This means that those individuals will report profits on their own personal tax return, but can only pay on tax that is equivalent to the amount of capital they invested in the business. Furthermore, these companies can potentially deduct business losses, thereby reducing their taxes owed.

C Corp Advantages

There are still many advantages to operating a C corp, and these include:

• Health insurance and other fringe benefits are not subject to ordinary income tax or employment taxes, which is generally the case with other business structures.

• Income can be split between the owners and the corporation. This is generally done to reduce overall taxes.

• Since the C corporation can issue an unlimited amount of shares, the corporation can increase its profits and funding by simply selling shares of stock.

While there are advantages and disadvantages (double taxation) to operating a C corp, you can also choose to operate as an S corp. Some items of consideration include the fact that C corps are so highly regulated and have a significant amount of government oversight. For this reason, such corporations might require the help of an accountant as well as an attorney to help in the accounting and legal departments.

When you initially incorporate, keep in mind that your corporation automatically defaults to a C corp. If you want to operate as an S corp, you must elect to do so.

If the business is going to earn profits from the very beginning, then operating a C corp would offer greater tax saving opportunities, along with more funding resources for future growth of the business. If, however, your business is expecting to incur a loss in the beginning of its operations, then you might want to elect to operate as an S corp so that the losses pass through to the owners, which they can then deduct against other earned income. Once you see your business turning a profit, you can then convert your corporation back to a C corp.

Taxation of C Corporations

A corporation is treated as a separate legal entity; therefore, it can purchase property, sue other parties, be named as a defendant in a lawsuit, and even enter into a contract. For that reasons, shareholders benefit from limited liability. The liability is limited because the only amount for which the shareholder can be held liable is the amount of money that he or she invested in the corporation. Their other personal assets cannot be taken, whether it be homes, automobiles, bank accounts, etc.

Keep in mind that there are some exceptions to this rule, particularly regarding potential fraudulent activities. If this is the case, the law would allow what’s called a ‘piercing of the corporate veil’ to hold one or more shareholders liable.

A C corporation has to use the accrual method of accounting if the gross receipts exceed $5 million for the preceding three tax years. If the corporation has not been in business for a period of three or more years, then you must calculate the average for the time in which the business has been operating. If the time period is less than one year, then the income would be annualized.

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