Tax Planning for C Corporations Using Tax Planning Software
The third article in our Deep Dive into Entity Selection series focuses on 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 ofcorporate 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 client’s tax position. Today, we want to explore the basics of C corporations – how they are formed, how they are taxed, and what benefits your clients might receive if their businesses are taxed as C corporations.
Formation
The process of incorporating a business is often a multistep process. To establish a corporation, your clients must:
Select a business name.
The name should identify that the business is a corporation by using the terms (or abbreviations of) “corporation”, “incorporated”, or “limited”. Your clients should also make sure their chosen name isn’t trademarked.
Determine where they wish to incorporate.
Tax regulations, liability protections, and corporate rights differ from state-to-state. If your clients want to know where they should incorporate, it would be wise to connect them to an attorney familiar with their industry.
Select a registered agent.
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.
Select a board of directors.
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 client’s top priority.
Establish bylaws.
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.
File articles of incorporation with the state.
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:
Identifying information about the corporation – name, address, etc.
Duration of the corporation
Corporation’s purpose
Registered agent information
Identifying information of the board of directors
Number, type, and par value of shares of stock that are authorized and issued
Issue stock to company shareholders.
Your clients 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 client’s lawyer involved to ensure the stock subscription agreements are correct.
Register with other governmental agencies.
As a corporation, your client will need to apply for an employee identification number (EIN) from the IRS. They may also need to register for sales/use tax and payroll tax with their state’s Department of Revenue. And lastly, if your clients are in certain industries, they may need to establish separate business licenses within their jurisdiction.
Liability
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.
Taxes
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:
Estimated Taxes
Just like individuals, corporations must pay their tax throughout the year. Form 1120-W helps a corporation estimate their quarterly installment payments.
Payroll Taxes
Payroll taxes include state filings, quarterly wage reports, annual reports (like W-2s, Form 940, Form 941,and Form 944).
Sales Taxes
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 show your client just how impactful sales taxes can be on their organization.
Property Taxes
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.
Advantages
A few advantages that corporate entities have over other types of business entities are:
The owners are protected from personal liability.
Unless a court pierces the corporate veil, shareholders will not be on the hook for debts of the business.
The business is perpetual.
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.
It’s easier to raise capital.
If a corporation needs an influx of capital, they can issue new shares of company stock.
It’s easier to transfer ownership.
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.
Disadvantages
The same income is taxed twice.
Double taxation only affects C corporations, not other flow-through entities like sole proprietorships, partnerships, or S corporations.
Corporations must comply with more rules and regulations.
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.
They must file more complex tax returns.
Most tax experts agree that corporate tax returns are more complex than tax returns of flow-through entities.
Next Steps
Corporations may be the ideal entity for your clients, 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 client’s 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 help your clients see their tax piece more clearly.Reach out to us to request a demo of our tax planning software and see for yourself how it can help make the entity selection process that much easier.
