C Corporations

The big knock on C Corps is that they might be tax inefficient, thanks to double taxation. For decades a corporation was also the only road to an S Corp. Wyoming invented the LLC in 1977, but most states did not follow suit until the 1990s, so if you wanted to avoid double taxation you first created a corporation and then elected S corporation taxation.

C Corp Double Taxation: The Math

Since the Tax Cuts and Jobs Act of 2017, yeah way way back when, corporations have enjoyed a flat 21% federal income tax rate, and unlike much of that law it never had an expiration date. But, not all that glitters is gold. Dividends are taxed again to you at up to 23.8% (the 0%, 15% or 20% qualified dividend rate plus the 3.8% Net Investment Income Tax). Here is the math on $100,000 of profit-

• The C Corp pays 21%, or $21,000, leaving $79,000.
• Distribute the $79,000 as a dividend and you pay another $11,850 at 15% or $18,802 at 23.8%.
• Combined, that is roughly 33% to 40% before state taxes.
• The same $100,000 of ordinary S Corp business income is generally taxed once at the shareholder level. At the top 37% federal individual rate, a full 20% Section 199A deduction produces a 29.6% effective federal income tax rate on that QBI before considering shareholder wages, payroll taxes and state taxes.

This is the double taxation part. The 21% rate also looks better than it is because people compare it to their top marginal bracket. Your effective rate across all of your income is usually much lower than your top marginal bracket, and for many closely held business owners earning $100,000 to $300,000, an S Corp can be substantially more tax efficient once reasonable salary, payroll taxes, Section 199A and the eventual extraction of C Corp earnings are considered.

We don’t run into too many business owners who want to make money but never spend it. Sure, you can enjoy a lasting 21% corporate tax rate, but to spend it you need to be taxed again at your dividend rate. Sure, you can create a sham loan from the corporation to you, but then again, it’s a sham loan, right?

We wrote about this back in 2020, when everyone was asking whether to dump their S Corp for the shiny new 21% rate. The numbers have moved a bit, but the conclusion has not-

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Salary Games in a C Corp

If you think you are clever and drive corporate profits down to zero with high owner salaries, this too unnecessarily pays more in overall taxes ultimately (payroll taxes being the main culprit). You will discover in a later chapter that the IRS requires reasonable salaries to be paid to shareholders who work in an S corporation (not too low); however, the same is true in a C corporation where an unreasonably high salary is a target for the IRS. Only a “reasonable allowance for salaries” is deductible (IRC Section 162(a)(1)), and the excess gets recharacterized as a nondeductible dividend. Seems odd, but true.

In other words, C corporation plus high salary, Bad. S Corporation plus low salary, Bad. Like Goldilocks, it needs to be just right to the IRS.

Benefits of a C Corporation

Not all is bad with C Corporations. C corporations offer liability protection comparable to an LLC and much easier transfer of ownership, since shares are simple to issue and sell. Taxes are paid at the corporate level to the IRS and states (either through an income tax or a business tax) on Form 1120. Notice the subtle difference: 1120 and 1120S.

C corporations can also provide owner-employees certain fringe benefits tax-free, including employer-paid health insurance and properly structured medical reimbursement benefits, subject to the applicable plan and nondiscrimination rules. In an S Corp, a more-than-2% shareholder is treated like a partner for many fringe benefit purposes under IRC Section 1372, so some of that tax-free employee treatment disappears. For example, shareholder health insurance premiums generally land in Box 1 of the W-2, although they can often generate the self-employed health insurance deduction on the shareholder’s individual tax return. This is one reason medical professionals and other high earners with big family medical costs sometimes look at a C Corp.

Because of the relatively low tax rate compared to the highest individual rate, C Corps can pay down debt more cheaply. Loan principal is not deductible, so it is paid with after-tax dollars. Make $1,000 of profit, use all of it to pay down the equipment loan, and you still owe tax on the $1,000. Yuck. So, the question becomes, if you must pay taxes on the $1,000, would you rather do it at 21% or 37%? We’ll give you a minute to decide with an optional chin rub. Again, this is predicated on smart budgeting and using excess cash to pare down debt versus that European cruise you’ve been eyeing.

Mothership Baby S Corp Construct

A corporation also makes a clean mothership. Unlike a partnership, a corporation does not have the Rev. Rul. 69-184 problem that prevents a partner from being an employee of the partnership. A corporation can also contract with a shareholder-owned service company, including a baby S Corp, when that company provides services.

In our Mothership Baby S Corp construct, each owner forms their own S Corp, and the C corporation mothership pays each baby S Corp a commercially supportable fee for services under a written agreement. The payment still must survive the usual rules: real services, ordinary and necessary business purpose, reasonable pricing, proper worker classification and the assignment-of-income and related-party rules where applicable. When properly structured, the fee reduces the C Corp’s taxable income before the 21% corporate tax and subsequent dividend problem come into play.

This is the arrangement WCG uses with its partners. A partnership mothership can work too, but partnership compensation rules create additional wrinkles that we explore in Chapter 2. We cover the Mothership Baby S Corp in fascinating detail there.

Can You Stockpile at 21% and Switch to an S Corp Later?

There is an accumulated earnings tax of 20% on profits piled up beyond the reasonable needs of the business (IRC Section 531), but the first $250,000 of accumulated earnings ($150,000 for personal service corporations) is generally safe (IRC Section 535(c)), and a business paying down legitimate debt usually has a reasonable need.

The bigger trap is the plan to stockpile cash at 21% and then elect S Corp status to pull it out without double taxation. It does not work that way-

• Earnings accumulated as a C corporation keep their C Corp character. Once post-election S Corp earnings are used up, distributions of the old earnings are still taxed as dividends (IRC Section 1368(c)).
• Appreciated assets carry a built-in gains tax for five years after the switch (IRC Section 1374).
• Too much passive income with leftover C Corp earnings can trigger a corporate-level tax and even terminate the S election (IRC Sections 1375 and 1362(d)(3)).

The 21% rate defers the second tax. It rarely erases it.

Section 1202 Qualified Small Business Stock (QSBS)

Here is the C Corp’s trump card, and the One Big Beautiful Bill Act made it bigger. Sell stock in a qualified small business and you can exclude up to 100% of the gain from federal income tax (IRC Section 1202). For stock issued after July 4, 2025-

• 50% of the gain is excluded after three years, 75% after four and 100% after five.
• The exclusion is capped per company at the greater of $15 million or ten times your basis.
• The company’s gross assets cannot exceed $75 million when the stock is issued.

The catches: the corporation must remain a C corporation during substantially all of your holding period, you generally must acquire the stock at original issuance, and the corporation must satisfy Section 1202’s active business requirements, including generally using at least 80% of its assets in one or more qualified trades or businesses. Health, law, accounting, consulting, financial services and several similar service businesses are excluded (IRC Section 1202(e)(3)). There are also redemption traps that can taint otherwise qualifying stock. California does not conform. But if you are building a qualifying business to sell, this changes the C Corp conversation entirely.

When a C Corporation Makes Sense

A C corporation is required for a Rollover as Business Startup (ROBS), where your 401k buys stock in your new company. An IRA can never own S Corp stock (Rev. Rul. 92-73). An IRA can own an LLC, the so-called checkbook IRA, which works for passive investments like rentals. Run an operating business that way, however, and you run into unrelated business taxable income, and paying yourself from an IRA-owned business is a prohibited transaction that can blow up the entire IRA (Ellis v. Commissioner, T.C. Memo 2013-245, aff’d 8th Cir. 2015).

C corporations might also be necessary for preferred stock, investors with different economic rights, foreign or entity shareholders, more than 100 shareholders and initial public offerings. If you have these needs, seek an attorney. A smart one.

There are a couple of softer reasons too-

• Keeping income off your Form 1040. Income that stays in the corporation does not show up on your individual tax return, which can matter when Social Security benefits, Medicare premiums or health insurance premium credits are tied to your income. Pay yourself a salary or a dividend and that advantage disappears.
• Employee ownership. Handing employees an LLC interest means K-1s for everyone and a messy explanation. Shares in a corporation are cleaner, which is exactly why WCG converted to a C corporation as we brought on partners and employee owners.

Don’t forget the golden rule where the person who has the gold makes the rules. Said differently, if an investor or venture capitalist wants to put their money with you, and they will only do so under a C corporation regime, you are stuck between a rock and a hard place.