Forming or restructuring a business is a major undertaking, and selecting the right entity type can affect everything from tax strategy to your ability to attract investors. While pass-through entities like LLCs or S corporations are often favored for their simplicity, there are compelling reasons why you might choose a C corporation, even with its greater complexities and the reality of double taxation.
#1 They want to attract more investors or prepare for an IPO
If you’re planning to go public, a C corporation is standard. An IPO requires the ability to issue common stock and comply with rigorous regulatory standards. The C corporation structure is inherently designed to meet these requirements, making it the most viable option for companies preparing for an IPO.
While venture capitalists and institutional investors may not always require a C corporation, certain features of this structure remain highly attractive to many types of investors. Unlike S corporations, which are limited to 100 shareholders who must be U.S. citizens or residents, C corporations have no such restrictions. This makes them more accommodating to larger pools of investors, including foreign entities.
One of the standout advantages of a C corporation is its ability to issue multiple classes of stock, such as common and preferred shares. While certain pass-through entities like LLCs can use operating agreements to mimic this capability, the process is often more complex and less standardized. The corporate framework of a C corporation simplifies this process, offering a clear and well-established structure for issuing different classes of stock. For investors, this means greater clarity and reliability regarding voting rights, dividend policies, and liquidation preferences – terms that are often central to negotiation. For example, venture capitalists typically require preferred stock with specific rights and privileges, such as priority over common shareholders in dividend payments or in the event of liquidation. The C corporation structure handles these requirements seamlessly, ensuring that both the company and its investors have a shared understanding of their rights and obligations.
The standardized governance of a C corporation also enhances its appeal. Features like a board of directors, regular shareholder meetings, and adherence to corporate bylaws are reassuring to investors, who may view the less formal structures of pass-through entities as ambiguous or inconsistent.
#2 Tax flexibility
Double taxation—first at the corporate level and then on shareholder dividends—is the hallmark challenge of C corporations. For owners who prioritize withdrawing a substantial portion of business income as dividends, the overall tax burden may be higher with a C-corporation than under a pass-through structure.
However, the ability to balance tax obligations between the corporation, wages, and dividends offers opportunities to optimize tax outcomes.
At the corporate level, profits are taxed at a flat 21% federal rate, providing a competitive baseline compared to the top individual rate of 37%. If the owner is also an employee, they can receive a reasonable salary. Wages are taxed as ordinary income for the owner/employee but are fully deductible for the corporation, reducing its taxable income. This minimizes or eliminates the risk of double taxation while keeping overall tax liability manageable. The corporation can also distribute income to shareholders as dividends. While qualified dividends are not deductible by the corporation, shareholders are only taxed at the capital gains rate, which is typically lower than ordinary income tax rates. This flexibility allows C corporations to adjust how profits are distributed to minimize tax liabilities.
C corporations also offer the ability to defer individual taxes by retaining profits within the business. This contrasts with pass-through entities, where shareholders are taxed on 100% of the company’s profits – whether those profits are distributed or not.
#3 Ability to use assets to secure loans
A key advantage of a C corporation is its ability to use its assets as collateral to secure loans. Since a C corporation is a separate legal entity, its assets are distinct from those of its shareholders. This separation not only simplifies the borrowing process but also shields shareholders from personal liability.
This separation also allows individual shareholders to use their shares as collateral for personal loans. Because C corporation shares represent a clearly defined ownership interest that is independent of the corporation itself, lenders may accept them as security. This benefit is relatively unique to a C corporation, as shareholders of other entity types may face more restrictions or complexities in pledging ownership interests as collateral. While the corporation’s assets remain protected and unaffected, the shareholder can leverage their equity stake to access personal financing, offering an additional layer of financial flexibility.
For founders of a C corporation, this structure creates a unique financial advantage. They may secure loans for the business without risking personal assets like their home while also using their shares to obtain personal financing without jeopardizing the company’s assets or operations. While pledging shares does carry the risk of losing them if the loan is not repaid, it avoids the more severe consequences of putting primary personal assets on the line, offering a distinct layer of financial security and flexibility.
#4 Reinforced liability protection through corporate formalities
While many entities, including LLCs, can offer limited liability protection for an owner’s personal assets, the built-in governance requirements of a C corporation often make its liability protection more robust in practice.
In a C corporation, shareholders are generally not involved in daily operations. They elect a board of directors to oversee major decisions, while officers handle the business’s management. This clear separation between ownership and management helps maintain a distinct corporate identity – reducing the risk that shareholders will be held personally liable for the company’s obligations.
Formalities such as regular board meetings, documented bylaws, and properly recorded corporate action further reinforce the legal divide between the corporation and its owners. Although LLCs can match this level of formality if structured and operated carefully, many smaller LLCs tend to mix personal and business dealings, which can weaken their liability shield.
For businesses with substantial assets or those engaging in high-risk operations, the standardized nature of a C corporation provides an added layer of protection. It allows for clear risk segregation, particularly in parent-subsidiary arrangements, and ensures that personal assets remain secure even in high-risk scenarios.
5-Strategic tax benefits
C corporations unlock certain tax benefits that are unavailable to pass-through entities. A prime example is the qualified small business stock (QSBS) exclusion. If your domestic C corporation meets the criteria for a qualified small business, shareholders may be able to exclude up to 100% of capital gains on the sale of stock, provided they hold it for at least five years. To qualify for the QSBS exclusion, the C corporation must meet specific criteria, including operating in an eligible industry and having less than $50 million in gross assets at the time of stock issuance.
Another noteworthy benefit relates to net operating losses (NOLs). While NOLs generated by a C corporation cannot be passed through to offset an owner’s personal income, they can be carried forward to reduce the corporation’s taxable income in future years. For businesses expecting rapid profitability, this can offset taxable income in more lucrative periods.
C corporations also differ from pass-through entities when it comes to the alternative minimum tax (AMT). Higher-earning individuals can be subject to AMT on their personal returns, but for most C corporations, the old corporate AMT (CAMT) was repealed in 2017. Under the 2022 Inflation Reduction Act, there is now a 15% book minimum tax on corporations with average annual financial statement income above $1 billion. This provision still functions as a minimum tax but only affects the largest corporations. Smaller and mid-sized C corporations still benefit from the repeal of the old CAMT and generally don’t face an AMT-like burden on their earnings.
Bringing it all together
The choice to establish or convert to a C corporation is rarely about the here and now; it’s about where you want your business to be in five, ten, or twenty years.
If your vision involves attracting significant investment, retaining earnings for reinvestment, or going public, the C corporation structure likely aligns with your goals. On the other hand, if your business thrives on simplicity or you plan to distribute most profits directly to owners, a pass-through entity may be more appropriate.
The best decision often lies in the details. Engage with experienced advisors to ensure your decision is both informed and aligned with your long-term strategy. For more personalized guidance and advice, please contact our office.
