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5 Reasons to Be a C Corporation
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5 Reasons to Be a C Corporation
The entity choice for starting or operating a business can have a number of implications. It can affect funding, taxes, and more. Here are five compelling reasons why you may want to run your business as a C corporation.
1. Use crowdfunding to raise equity capital
The Jumpstart Our Business Startups (JOBS) Act of 2012, which became law last month, allows the Securities and Exchange Commission (SEC) to revise its rules to enable businesses to raise equity capital through crowdfunding. (Currently, crowdfunding is limited to seeking contributions through such sites as *Kickstarter. This means that small businesses will be able to raise capital from numerous small investors without having to comply with onerous registration requirements. Online websites, such as *EquityNet, will facilitate this type of equity funding.
While the SEC has not yet released regulations on crowdfunding, it is likely that only C corporations will be in a position to take advantage of the opportunity to raise equity through crowdfunding. S corporations, for example, have a 100-shareholder limit, effectively precluding the use of crowdfunding. Expect to see SEC regulations and guidance near the end of this year and for crowdfunding to begin in 2013.
2. Maximize medical deductions
Owners of a C corporation can receive health coverage on a tax-free basis. The corporation can fully deduct its premiums. In contrast, S corporation shareholders must report the benefit as income and then deduct the premiums from gross income on their personal returns—this is merely a wash. Self-employed individuals also deduct their premiums from gross income on their personal returns; they cannot reduce their business income by the premiums allocable to their personal coverage and wind up effectively paying self-employment tax on the premiums.
A C corporation can also set up medical reimbursement plans to pay fixed dollar amounts for out-of-pocket medical costs of employees. As long as the plan is nondiscriminatory (i.e., does not favor owners), the reimbursements are not taxable to employees, while they are deductible by the corporation. One client of mine who had a severe disability was able to handle many of his medical costs through the reimbursement plan that covered his corporate employees -- himself and his wife.
3. Foreign investors
In a recent SBA report, about two-thirds of immigrant-owned businesses reported that the most common source of startup capital was personal or family savings. In order to facilitate the use of foreign investments—for immigrant-entrepreneurs or any other companies -- C corporations may be the best entity choice. S corporations, by definition, cannot have any nonresident alien shareholders.
4. Using multiple classes of stock
Not all owners are created equal. Some may be entitled to a greater voice in the operations of the business, or have more of a say about certain strategic activities, such as a merger. In order to effectuate the distinctions among owners, it is not enough merely to have majority and minority owners. In a C corporation, there can be different classes of stock to reflect the desire for only some shareholders to participate in company business. This may be helpful to keep decision-making in one class but enable participation in earnings with an additional class.
S corporations are limited to one class of stock. Limited liability companies, which do not have stock at all, can limit participation of some owners by having member-managers. However, even these non-managers may have more participation in the business than would otherwise be desirable.
5. Minimizing employment taxes
Currently, self-employed individuals (including partners and LLC owners) pay self-employment tax to cover their Social Security and Medicare taxes obligation on all of their net earnings from self-employment. (There are some exceptions, such as for limited partners and for LLC owners who perform no services for the business.) In contrast, shareholder-employees of S and C corporations pay FICA (Social Security and Medicare) taxes only on wages they receive. This may change.
Recently, during Congressional plans to extend the low-interest rates on certain student loans, it was proposed (S. 2343) to impose a self-employment-like tax on S corporation earnings for those in professional services businesses. Only owners with income of not more than $250,000 ($200,000 for singles) would be exempt from this change. At the time this article was written, the fate of this tax change was unknown. Whether it passes this time or not, the writing is on the wall!
If you are operating a business using an entity other than a C corporation, such as a limited liability company or S corporation, work with your tax and legal advisors to determine whether it makes sense for you to make a change. Factor in the advantages to be gained as well as the tax and financial cost of making the change.
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