Although becoming a C Corporation involves more paperwork and continuous compliance, many business owners find the C Corporation’s flexible tax treatment options worth the extra work.
C Corporation Default Tax Treatment
As a separate entity, when a C Corporation makes a profit, it is taxed on that income. Shareholders are taxed on the salaries/dividends they receive from the company, which is why you often hear a C Corp’s income tax treatment referred to as “double taxation.”
As of the 2017 Tax Cuts and Jobs Act (TCJA), a C Corporation’s profits are taxed at the flat 21% corporate income tax rate. Depending on the location and shareholders’ personal tax situation, the flat tax rate may work in the business owners’ favor. However, the TCJA also limits the percentage of business entertainment deductions allowed, although, for 2022 tax returns, you can deduct 100% of your business expenses spent at restaurants. On 2023 tax returns, that figure returns to 50%.
Still, a C Corporation has the most allowable deductions of any business structure. For example, C Corporations can deduct expenses related to the cost of having employees, such as:
- Retirement plans
- Employee training
- Vacation and sick pay
- Employee education
In addition, C Corporations can deduct many operational expenses such as leasing costs, professional fees, business permits and licenses fees, subscriptions, work vehicles, and insurance premiums.
A C Corporation often pays taxes at a lower federal income tax rate than Sole Proprietorships and Partnerships’ individual income tax rates. So, business owners planning to invest earnings back into the company typically prefer the C Corporation structure to save on federal income taxes.
The S Corporation Election
To avoid double taxation, eligible C Corporations can elect to be taxed as an S Corporation or Sub-Chapter S Corporation. Although the S Corporation is formed as a C Corporation, the entity makes an S Corporation election by filing Form 2553 with the Internal Revenue Service (IRS) to be taxed as a pass-through entity.
With the S Corporation Election, the corporation is then not treated as a separate taxable entity, and the profits and losses are passed-through and reported on the personal income tax returns of the shareholders. S Corporation owners save on taxes because only owners’ salaries are subject to self-employment tax; shareholder profits given as distributions are not.
Although bypassing double taxation seems favorable, discussing your company’s tax situation with your accountant is crucial to get a reasonable projection of how the election affects its future profits and taxes. Also, the S Corporation has specific limitations on ownership, unlike the C Corporation. An S Corporation has a limit of 100 shareholders, and all shareholders must be citizens of the United States.
State Corporate Taxes
In addition to the federal corporate tax, most corporations must also pay corporate taxes in their states. According to the Tax Foundation, 44 states currently levy a corporate income tax with 2023 tax rates ranging from 2.5% to 11.5%.
Other corporate tax findings include the following:
- Highest Corporate Rates – Alaska, Illinois, Minnesota, and New Jersey are the states with the highest corporate income tax rates of 9% or higher.
- Lowest Corporate Tax Rates – Arizona, Colorado, Indiana, Kentucky, Mississippi, Missouri, North Carolina, North Dakota, Oklahoma, South Carolina, and Utah have the lowest rates of 5% or below.
- Levy Gross Receipts – A gross receipts tax is applied to a business’s gross sales without deductions for the company’s business expenses. The states of Nevada, Ohio, Texas, and Washington levy gross receipts taxes instead of corporate income taxes. Delaware, Oregon, and Tennessee impose gross receipts and corporate income taxes. Some cities and counties in Pennsylvania, Virginia, and West Virginia also impose gross receipts taxes.
- No Corporate Taxes – South Dakota and Wyoming don’t levy corporate income or gross receipts taxes.
Of the 44 states that levy a corporate income tax, 15 states have a graduated tax rate, while the remaining 29 states impose a flat corporate income tax rate. For remote sellers, each state has its own guidelines for what constitutes nexus (doing business) in the state and what taxes are due to the state. In general, sales and income taxes are due for the products sold to recipients living in the state.
For more on economic and income nexus, see A State-by-State Guide to Economic Nexus.
Ready to Form a C Corporation?
If you have decided that forming a C Corporation is the right choice for your business, CorpNet is here to help you with all of your business registration and compliance filings. Contact us today to save time, money, and hassles as you incorporate your company and fulfill your dreams of entrepreneurship!