C corporations serve as legal entities in which the owners, or shareholders, are taxed separately from the business entity. This offers liability protection for its shareholders.
While the popularity of this entity type took a dip for many years, the “Tax Cuts and Jobs Act of 2017,” cutting the tax rate for C corporations from 35% to 21%, has caused this entity type to make a comeback in demand in recent years.
C-corp bylaws
Bylaws are the rules of a corporation that will be performed throughout the organization’s existence. Bylaws govern how a company is operated and are one of the first items to be created by the board of directors. While the bylaws are often included with the Articles of Incorporation as a single document, bylaws, and Articles of Incorporation are legally separate, distinct documents. Bylaws are not required to be filed with the state of origin’s agency of business registration.
The following bylaws should be factored into a C-corp’s structure:
- Board of directors: The board is the governing body of the corporation. The bylaws should outline the board’s powers and duties, the number of years a member can remain on the board, the number of members required to form a quorum, and how to replace a member.
- Identification information: Name, address, and principal place of business; designation of the corporation as public or private
- Stock information: If the organization is a stock corporation, the bylaws should have information about stockholders and voting shares of stock, the number, and type of shares, and the types of stock classes the corporation is authorized to issue
- Statement of the company’s purpose: this explains why the company was formed; may be helpful in attracting investors because of a central location to ascertain what the company is all about
- Shareholder and board meetings: bylaws should indicate when, where, and how often shareholder meetings take place and how to notify shareholders of these meetings.
C-corps and institutional investors
C corporations make dividing ownership easy through the issuance of stock. Dividing ownership can also be done with other entity forms, such as LLCs, but it is significantly more complicated.
Ease of dividing ownership is one reason why institutional investors prefer – and sometimes require – a business to be a C corporation.
Some investors don’t want just any C corporation – they prefer a Delaware C corporation. As detailed in an earlier section of this article, the state of Delaware features a corporation-friendly court system as well as formation flexibility.
If you know for certain that your business will be welcoming investors in the future, consider making your business a C corporation from the very beginning. You can always start a business as an LLC or an S corporation, then convert to a C corporation, but that process could be very expensive and time-consuming.
C-corp stock-based compensation packages
In the early days of a start-up company when cash can be at a premium, new employees can be incentivized to work for the start-up by being offered equity incentives. Stock-based compensation packages are also a great way to tie the employee’s financial rewards to the success of the company.
Several of the equity-based incentive plans allow employees to defer paying tax on the equity compensation they receive until the underlying stock associated with the incentive package is sold. When the employee sells the stock at some point in the future, the employee will then recognize income and the business can recognize a wage and salary deduction.
While LLCs can offer their members or partners what is called a “future profits interest,” it can’t offer a future value of the partnership as a compensation arrangement. So if the business wants to tie compensation to the equity of the business, the C corporation is the easiest way to structure this type of pay package.
C-corp stock options and restricted stock
Most equity compensation packages are offered as either grants of stock options or issuances of restricted stock. Stock option plans are more common with startups while restricted share plans are more common for established companies.
Here is a quick look at the most common types of stock grants and options:
- Stock Grant of Restricted Shares: Restricted shares are shares of a business’s stock that vest over time to an employee. An employee cannot sell the stock until the shares have vested. Receiving restricted shares is not a taxable event and doesn’t cost anything to the employee. When a restricted share finally vests, the employee must recognize the vested share’s fair-market value as ordinary income. The employee also must pay either short-term or long-term capital gains when the stock is eventually sold.
- Stock Grant of Unrestricted Shares: Rather than restricting when an employee can be awarded stock of a business, shares can be immediately transferred outright to the employee. While receiving unrestricted shares gives an employee immediate equity in a company, it also means the employee must immediately pay taxes on the fair market value of the shares less the amount paid for the shares.
- Incentive Stock Options: With an Incentive Stock Option (ISO) compensation plan, the employee does not have to pay taxes until the stock is sold. If certain holding period requirements are met, the stock sale proceeds will also be eligible for long-term capital gains treatment. With ISO’s, the C corporation does not receive a deduction when the employee sells his or her shares if the long-term capital gain holding requirements are met.
- Non-Qualified Stock Options: With a Non-Qualified Stock Option (NQSO) compensation plan, an employee is permitted to acquire an agreed-upon number of stock shares at a future date (or dates) for a pre-determined price. (These plans are called “non-qualified” because they do not meet all the criteria required by the IRS to qualify as ISOs.) For example, an employee is hired January 1, 2022 and provided an NQSO plan. The NQSO states that the employee can purchase one share of the company’s stock for $50 at a future date. On January 1, 2024, the employee purchases one share of company stock for the agreed-upon $50 while the fair market value of the share was $60. The employee must include as income on their tax return the fair market value of the stock at the time it was acquired less any amount paid for the stock. In our example, the employee would have to include income of $10 (FMV of $60 less $50) as income on their tax return.
Profits of a C corporation go into a bucket called “accumulated earnings and profits.” A dividend is a distribution made to shareholders from cash found in this “accumulated earnings profits” bucket. So another way to think about dividends is that they are distributions of earnings by a corporation to its stockholders.
But how, exactly, do dividends end up in the hands of stockholders? Only the board of directors can declare dividends. Dividends are usually paid quarterly, though a company can issue special, one-time dividends under special circumstances.
C-corp mergers and acquisitions
Instead of starting a business from scratch, suppose you wanted to buy a business instead.
One option is to purchase the individual assets of the company you wish to acquire. There would be separate transactions for all the assets on a balance sheet – accounts receivable, fixed assets, inventory, any intangible assets, etc. If there were any liabilities, those also might affect the purchase price of the assets.
Entering into separate transactions for each of a business’s assets can quickly become very cumbersome.
Instead of buying individual assets, a C corporation allows a potential buyer to purchase the company via shares of stock. Each share represents a fractional amount of the balance sheet, which makes mergers and acquisitions which are completed via stock swaps quick and easy.
B-Corporations (benefit corporations) are also C corporations with a specific designation
A Certified B-Corporation, also known as a benefit corporation, is a type of for-profit corporate entity recognized by 35 states and the District of Colombia. These corporations create value not only for their stockholders but also for society at large.
B Corporations are companies certified by “B Lab” as meeting certain standards of social and environmental performance, accountability, and transparency.
Don’t be fooled by the name “benefit corporation,” however. B-Corporations are taxed just like C corporations. They are not considered non-profit entities.Strict year-end requirements for properly maintaining C corporation status
A common reason for incorporating a business is to limit the personal liability of the shareholders if the company is sued. Limiting personal liability, however, isn’t a benefit that’s granted indefinitely after the Articles of Incorporation are filed.
A C corporation must remain in good standing with the state in which the Articles of Incorporation were filed (this also applies to LLCs) at all times by adhering to a prescribed list of rules in order to maintain limited liability. If the corporation finds itself not in good standing, a third party can sue the business and come after both the business’s assets as well as the shareholders’ assets. This is commonly referred to as “piercing the corporate veil.”
Here are some of the most common rules that must be followed to maintain a C corporation’s “good standing”:
- File annual information reports – Most states require some type of annual information report. Double-check due dates – some reports need to be filed when tax returns are due, and others are due on the anniversary of the incorporation or at the end of the calendar year.
- Keep corporate minutes and resolutions – Minutes, also known as “minutes of the meeting,” are the contemporaneous written record of a meeting. Minutes content typically includes the time and place of the meeting, individuals in attendance and the chair of the meeting, decisions made or actions taken, along with the signature of the recorder and the date. Meeting minutes should be recorded even if there is only one corporate owner. Minutes are often used as a defense in court to protect a corporation’s ability to limit shareholder personal liability.
- File amendments to record any changes – Changing an address, changing a website URL, issuing more shares of stock – any change to the corporation must be reported to the corporation’s home state by filing an “amendment” to the original articles of incorporation. Many states refer to these changes as “Articles of Amendments.”
- Keep business finances separate from personal finances – For a small business owner, keeping separate checking accounts for business and personal transactions can be a hassle. But if you incorporate your business, maintaining separate accounts is a requirement. There should be separate accounts for everything money-related in a corporation – checking accounts, savings accounts, credit cards, etc. Keeping separate business accounts will also make tax time easier since all business income and expenses will be in one place.
- Register in all states where the corporation conducts business – A corporation operating in a state other than where the Articles of Incorporation were filed is referred to as a “foreign corporation.” Other state-specific licenses and permits may also be required.
Choosing the right structure for you
Understanding the tax differences between entities is fundamental to your business development process. Your business entity structure directly impacts your tax obligations and should be carefully considered when considering starting a business, or when you’re wanting to change entity structure type.
Fusion CPAs understand the tax implications per entity and can look at our business needs to help you decide on the most suitable entity type for you.
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.
