Definition of a C-Corporation

By Jeff Franco J.D./M.A./M.B.A.

Classification of a corporate entity as a C corporation rests entirely on whether it’s subject to the income tax rules in subchapter C of the Internal Revenue Code, or IRC. The C corporation designation solely relates to income tax, so states make no distinction when you create the entity. However, many state taxing authorities recognize the designation for state income tax purposes.

C Corporations

To be considered a C corporation, two requirements must be met: The business must be recognized as a legal corporation in the state of its formation, and it cannot elect to be taxed under any provisions of the IRC other than subchapter C. For example, if you create a limited liability company, or LLC, in California, and elect C corporation status for federal tax purposes, the state will recognize the LLC as a C corporation. In contrast, if you create a corporate entity as an S corporation for federal income tax purposes, the federal government as well as most states will recognize your corporate entity only as an S corporation.

Taxation of C Corporations

Subchapter C of the IRS treats a C corporation as a separate taxpayer from its shareholders. The IRS requires the annual filing of a corporate tax return on Form 1120 or 1120A, and the tax return must report all corporate income and deductions. The corporate filer must calculate the amount of net earnings that are subject to the corporate tax rates, which generally range from 34 to 39 percent on corporate income that exceeds $100,000.

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Double Taxation

The most distinctive characteristic of a C corporation is that it is subject to a system of double taxation. A C corporation must first pay tax on its earnings by filing Form 1120 or 1120A; then its shareholders are taxed a second time on their separate income tax returns when they receive dividends. Since dividends aren’t deductible on a corporate tax return, taxable dividends come from earnings that have already been taxed at the corporate level.

Other Corporate Designations

S corporations, which are subject to the tax rules of subchapter S of the IRC and personal service corporations are two of the more common types of corporate entities that have characteristics that distinguish them from C corporations. The shareholders of an S corporation receive the same personal liability protection as shareholders of a C corporation, but are subject to pass-through taxation rather than corporate taxation. Personal service corporations are designated as such when the owners of the corporation earn a majority of the income through the provision of services. In this case, a flat rate of tax applies to all earnings.

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What Forms Do I Need to File for an S Corp?

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Tax Planning for an S Corporation

If you incorporate or create a limited liability company (LLC) for your small business, you may be able to designate it as an S corporation for federal income and self-employment tax purposes. Most of the income tax planning for an S corporation will be of more use to a corporation than an LLC, but LLC members still stand to save a substantial amount of self-employment tax with an S corporation election.

S Corporation Passive Income Restrictions

An S corporation is a corporation consisting of 100 or fewer shareholders that has a special tax designation granted by the IRS. While this designation offers the shareholders certain tax benefits, it requires the company to adhere to several restrictions and conditions. One of these restrictions involves how much passive income the business earns. It is important for an S corporation to closely monitor how much passive income it earns to ensure that it avoids any IRS penalties or tax repercussions.

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