Business Entity: Sub Chapter C-Corporation

“C” Corporations - or "C" Corp - are named after sub chapter “C” of the Internal Revenue Code. Another common description for a “C” Corporation is a “Standard” or “Regular” Corporation.

After the initial filings, a “C” corporation can begin business. In most cases a “C” corporation can elect to have a taxable year other then a calendar year (called a fiscal year). However, if the corporation is deemed a “Personal Service Corporation” or a “Personal Holding Company”, it cannot have a taxable year other then a calendar year.

The major disadvantage of a “C” Corp is that the corporation pays income taxes on its earnings and, when the earnings are distributed as dividends, the Shareholders pay taxes again. Basically, this is double taxation.

While you may think that this is easily circumvented, the law was designed to prevent abuse of the system.

In 1913 when the predecessor to the Internal Revenue Code was enacted, congress attempted to block abuses from the very beginning.

The Internal Revenue Bureau was given the authority to allocate “reasonable compensation” where excessively high salaries and bonuses were paid. At that time, Congress realized that while several businesses were extremely large, the total number of shareholders was small. In most cases the shareholders were family members. As such, it would be a simple matter to pay the shareholder/officer bonuses to eliminate all corporate profits.

Since the Treasury Department had this authority, they would disallow substantial bonuses to the officers and convert them to dividends. This would effectively eliminate the corporation deduction for salary. Basically the corporate income was increased, subjecting it to corporate income taxes. Since dividends are not deductible by the corporation but are includable in the shareholder’s income, the shareholder’s / officer’s income would remain unchanged.

Another “trick” to diminish the effects of double taxation, was to allow earnings to accumulate inside the corporation until the shareholders were in a significantly reduced tax rate. At this later date, the shareholders could receive dividends at a substantial savings in tax.

In order to avoid this, congress instituted the “Accumulated Earnings Tax”. Basically this is a tax on earnings that have accumulated beyond the reasonable needs of the corporation. While the concept of excess accumulated earnings is very subjective, congress established a $250,000.00 minimum threshold, ($150,000.00 for certain service corporations). This “threshold” is the amount of accumulated earnings that a business can successfully retain without having this tax imposed. There are several other methods which allow corporations to qualify a higher amount of retained earnings.

Since the penalty tax is 15.0% on the excess accumulated earnings, corporations should provide “business needs” to substantiate accumulated earnings in excess of that amount. Another method for avoiding this tax is to establish a “regular” dividend policy.

Corporate income taxes are based upon “taxable” earnings. Taxable earnings consist of the corporation earnings increased by 50% of disallowed meals and entertainment expense, and all other earnings are also disallowed deductions such as tax penalties, non allowed losses, and other such items. The net is subjected to Federal Income Taxes decreased by any non taxable income.

The tax rate is dependant upon whether the corporation is classified as a personal service corporation, a personal holding company or a regular corporation.

    Regular Corporate Tax Rate
    0 - 50,000 15%
    50,000 – 75,000: 25%
    75,000 – 100,000 34%
    100,000 – 355,000 39%
    355,000 – 10,000,000 34%
    Over 10,000,000 35% - 38%
    Income 4.8% over $1,000.00
    Replacement Tax 2.5% over $1,000.00

    Personal Service Corporation

    • Federal - Fixed 35% rate on all income
    • Illinois - Same as Regular Corporation

    Personal Holding Corporation

    • Federal - Regular Corporate tax rate plus 15.0% of all undistributed personal Holding company income.
    • Illinois - Same as Regular Corporation

Advantages of a C-Corporation:

  1. Separate Entity
  2. Corporate Protection
  3. Officer’s Benefits fully deductible (if non discriminatory)
  4. Fiscal year allowed if not a Personal Holding Company or Professional Service Corporation
  5. 5axes can be avoided provided that a “Reasonable” salary can eliminate all income.

Disadvantages of a C-Corporation:

  1. Double taxation of any remaining income.
  2. No Family employment benefit. All wages subject to Social Security and Medicare and Unemployment.
  3. Taxpayer & spouse are treated as one stockholder
  4. Profits are distributed based upon shares held and cannot be altered other than through payroll.