There is two types of corporation structure: C-corporation and S- corporation. In this article, we are only focused on C-corporation’s business structure and tax. However, there are some pros and cons of starting a business as a corporation, it is depended on the business long term goal and future development.
Some people may ask why some corporation is incorporated in Delaware, but they are located in California and doing business worldwide. Actually, Delaware is a business-friendly state, and it provides limited liability, ease of use, ease of setup, the ability to issue stock options, and tax benefits upon sale for many qualified small businesses.
We are going to learn about the formation of a C-corporation and how corporations are taxed.
Forming a Corporation
For every business structure, the first thing to do is to choose a corporate name. The name should be unique and must comply with the rules of your states; corporation division. After the name is chosen, you should appoint the director. Director is the person who makes major policy and financial decisions for the corporation, and the tile is different for LLC (Managing Member) and Partnership (General partner). In addition, directors are typically appointed by the initial shareholder(s) of the corporation before the business is started. Sometimes, the owner simply appoints themselves to be the director, but the director does not have to be owners.
Next, you must prepare and file “article of incorporation” with your state’s filing office. It is the basic document creating the corporation. Without an “article of incorporation” or ”certificate of incorporation”, it is not a corporation. Once the article is filed, you should draft a corporation bylaw. Bylaws are the internal rules that govern the day-to-day operations of a corporation, such as when and where the corporation will hold directors' and shareholders' meetings and what the shareholders' and directors' voting requirements are. Furthermore, you should not do business as a corporation until you have issued stock. Although your corporation is not trading public, it is a requirement of doing business as a corporation by issuing stock to divide up an ownership interest in the business.
Finally, after you've filed your articles, created your bylaws, held your first directors' meeting, and issued stock, you're almost ready to go. The last step is to obtain the required license and permits that you need to start a new business, such as a business license from the state and employer identification number from the IRS.
The business formation process could be complicated or straight forward, it is depended on the type of business you are doing. Although corporation owners may need to pay more taxes than other business owners in other business structure, the corporation still can get more flexibility than other business structure. For instance, a corporation can issue stock to over 100 people, which partnership can’t. Also, a corporation can deduct the full cost of fringe benefits provided to employees, which LLC or Sole entrepreneurship can’t.
How corporation are taxed
We can look at corporation tax as an onion. It is taxed from a layer (corporation level) to another layer (shareholder level). It is referred to as a double tax entity. That is the biggest drawback for many business owners don’t want to form a business as a corporation.
The corporation must file a corporate tax return, IRS Form 1120, and pay taxes at a corporate income tax rate on any profits. If a corporation will owe taxes, it must estimate the amount of tax due for the year and make quarterly payments to the IRS by the 15th day of the 4th, 6th, 9th, and 12th months of the tax year. However, if the corporation's owners work for the corporation, they pay individual income taxes on their salaries and bonuses like regular employees of any company. Salaries and bonuses are deductible business expenses, so the corporation does not pay taxes on them.
There are two ways for a shareholder to take money out from the corporation accurately, one is paid salary through payroll, which mentioned above, and another one is pay dividend through the corporation’s profit. Therefore, if a corporation distributes dividends to the owners, they must report and pay personal income tax on these amounts. And because dividends, unlike salaries and bonuses, are not tax-deductible, the corporation must also pay taxes on them. This means that dividends are taxed twice -- once to the corporation and again to the shareholders.
The Tax Cuts and Jobs Act: Award for Corporation
Due to the new tax reform starting in 2018, the U.S government give some “award” to U.S Corporation. One of the “award” is the lower corporation tax rate. During 2018 through 2025, corporations pay a flat tax of 21% on all their profits. The 21% rate is lower than the top five individual income tax rates in the past year, which range from 22% to 37%. The benefit of the lower rates is largely lost due to double taxation if corporate profits are distributed to the shareholders, who must pay individual income tax on such dividends. However, many corporations want or need to retain some profits in the business at the end of the year.
The purpose of this “award” is to fund expansion and future growth of the corporation. If the money retains in the corporation, the corporation only pays the 21% corporate income tax rate. Therefore, corporation owners can save money by keeping some profits in the company. The IRS will allow a corporation owner to leave profits in the corporation, up to a limit of a total of $250,000 (at any one time) in the corporation without facing tax penalties.