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The third article in our Deep Dive into Entity Selection series focuses on taxes for corporations.
A corporation is a legal entity that is separate and distinct from its owners. In many aspects, corporations are treated as persons by both state and Federal law. They have the right to enter into contracts, the right to fair and just trials, and the right to own property. In fact, Title 1, Chapter 1 of the United States Code of Law states that the term “person” should include corporations.
This concept of corporate personhood extends beyond legal rights and responsibilities. Our tax laws also treat corporations as persons. They are required to file their own tax returns, and they are required to pay their own taxes. If a corporation fails to pay tax, the IRS will seek restitution from the corporation, not from the corporation’s owners.
For tax purposes, there are two types of corporations: C corporations and S corporations. Corporate entities are taxed as C corporations by default, but the corporation may elect different tax treatment by making an S election. Electing to be taxed as an S corporation will be the right move for some businesses but not for others. A good tax planning software will show you just how much of a difference this simple election can change your tax position. Today, we want to explore the basics of C corporations – how they are formed, how they are taxed, and what benefits you might receive if your business(es) are taxed as C corporations.
The process of incorporating a business is often a multistep process. To establish a corporation, you must:
The name should identify that the business is a corporation by using the terms (or abbreviations of) “corporation”, “incorporated”, or “limited.” You should also make sure your chosen name isn’t trademarked.
Tax regulations, liability protections, and corporate rights differ from state-to-state. If you want to know where you should incorporate, it would be wise to connect with an attorney familiar with your industry.
A registered agent is a person (or business) that resides within the state who is appointed to receive legal and tax documents on behalf of the corporation.
A corporation’s board of directors may be comprised of the corporation’s owners, but directors are not required to be affiliated with the business. The directors help steer the direction of the corporation to be in alignment with the wishes of the shareholders, so selecting a competent board should be your top priority.
Bylaws govern how the corporation is managed. Bylaws outline business goals, details about corporate stock (like when new stock can be issued), the procedures for annual meetings, requirements for board members (including term lengths, rights, and responsibilities), information about committees, the procedures for appointing new officers, and others.
Articles of incorporation are simple forms that establish the business as a corporation. In most states, the following information will be included in the articles of incorporation:
You can only issue the amount of stock authorized in the articles of incorporation, which is why the articles of incorporation and bylaws are so important. Get your lawyer involved to ensure the stock subscription agreements are correct.
As a corporation, you will need to apply for an employee identification number (EIN) from the IRS. You may also need to register for sales/use tax and payroll tax with your state’s Department of Revenue. And lastly, if you are in certain industries, you may need to establish separate business licenses within their jurisdiction.
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Corporations are desirable because of the liability protections they provide. Corporations are considered distinct and separate from their owners, which means that shareholders are almost never personally liable for the debts of the corporation. However, in rare circumstances, courts may need to “pierce the corporate veil” to collect business debts.
In court proceedings, a judge may hold certain shareholders personally liable for corporate debts. This happens most often in close corporations, which are smaller, non-publicly traded corporations with few shareholders. Courts will typically only pierce the corporate veil when (1) the owners comingle their personal affairs with that of the business, (2) the company committed a fraudulent act or was created solely to escape liability, and (3) the company’s creditors were financially harmed by corporation’s actions.
Most corporations are required to file Form 1120, U.S. Corporation Income Tax Return, but corporations operating in certain industries may need to file a different version of Form 1120. For example, cooperative corporations must file Form 1120-C, and political corporations must file Form 1120-POL.
Form 1120 and its iterations report the entirety of the business’s activity: income, gains, losses, deductions, credits, tax owed, and tax paid. The Federal form is around six pages long, but most businesses will need to file additional forms and supporting schedules, making the tax filings more complex than many other business entities. States also have their own versions of Form 1120.
Unlike non-corporate entities, the owners do not report and pay taxes on the entirety of the business’s earnings. Individual shareholders only report income from their corporation when they receive a dividend. This is where “double taxation” comes into play. Business income gets taxed initially at the corporate level, then again at the shareholder level as dividends.
In addition to Federal and state income taxes, corporations need to think about:
Just like individuals, corporations must pay their tax throughout the year. Form 1120-W helps a corporation estimate their quarterly installment payments.
Payroll taxes include state filings, quarterly wage reports, annual reports (like W-2s, Form 940, Form 941, and Form 944).
Sales taxes are an ever-growing area of concern for businesses of all types, not just corporations, and as an advisor it’s important that you utilize your tax planning software to determine just how impactful sales taxes can be on your organization.
Property taxes are assessed by local jurisdictions, and businesses that own real estate and/or tangible property will likely be liable for property taxes within their state.
A few advantages that corporate entities have over other types of business entities are:
Unless a court pierces the corporate veil, shareholders will not be on the hook for debts of the business.
Most corporations will exist beyond the death of its owners, which gives a business more time to grow and expand its influence in the marketplace.
If a corporation needs an influx of capital, they can issue new shares of company stock.
Unlike partnerships that require new agreements and contracts when a partner wishes to leave, it’s much simpler to divest oneself of corporate ownership. A shareholder must simply sell their stock shares, which they can do in the public marketplace (if the entity is publicly traded), to another investor, or back to the company itself.
Double taxation only affects C corporations, not other flow-through entities like sole proprietorships, partnerships, or S corporations.
Many states impose more stringent rules on corporations, including the requirements to: file annual reports, file Articles of Incorporation, hold annual meetings, publish bylaws, and comply with corporate governance oversight requirements.
Most tax experts agree that corporate tax returns are more complex than tax returns of flow-through entities.
Corporations may be the ideal entity for you, but it’s important to look at all the options. It may be smart to make an S election or pivot away from corporations and establish an LLC instead. There are legal and regulatory requirements to consider, but when thinking about the tax consequences of entity selection, we have you covered. Our Corvee Tax Planning software can help you see how entity selection will affect your final tax bill. Taxes are one of the leading financial and compliance concerns for business owners, so you should do everything in your power to see your tax piece more clearly. Reach out to us and see for yourself how it can help make the entity selection process that much easier.
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