If you have a C Corporation, then you will need to file a Form 1120 (the “C” in the name refers to the section of the IRS tax code). Even if you own all or a part of the company, the IRS does not consider you to be self-employed. As a result, you will not only have to file a Form 1120 but a 1040 for yourself.
The big knock against a C Corporation is “double taxation.” To see why, here’s an example:
ABC Corp. generates a profit of $10,000 for the year. On Form 1120, the company will pay a tax. Let’s say it amounts to 15% or $1,500. Then, when this is distributed to the shareholders via a dividend, there will also be taxes owed on this too!
Bad deal, huh? Well, for the most part, owners of C Corporations find ways to avoid this. Generally, this includes increasing salaries, fringe benefits or leasing assets, which are deductible. The result is that there will be a loss or break-even for the C Corporation – and there will be no corporate taxes owed.
If there is an operating loss, then it belongs to the C Corporation. It does not pass through to the shareholders. But the operating loss can be applied to future profits.
As for Form 1120, it is required to be filed whether a C Corporation generates any income or not. The due date is also on March 15th (this is assuming the corporation is using a calendar year). If the deadline cannot be met, there is the option for a 6-month extension. But of course, any taxes owed must be paid by March 15th.
If a C Corporation retains earnings, the tax rates are generally more favorable than for an individual (especially when you add the requirement for self-employment tax, which is not included on Form 1120). This is the case up to $100,000. After this, there is a surcharge that wipes out the advantage.
But all this brings into play “income splitting.” That is, you can leave up to $100,000 in the C Corporation and then devote the rest of the money to fringe benefits.
This can turn out to be a tax-savvy move. The fringe benefits – such as health insurance and medical reimbursement plans — may not only be tax deductible for the C Corporation but are usually tax-free for the employee.
Other things to consider with a C Corporation include:
- When setting up a C Corporation, you might want to issue Section 1244 stock. You will get better tax treatment if there is a loss.
- A C Corporation can take deductions for charitable contributions
- There will be an annual franchise tax for the state
- Make sure you abide by the requirements of the C Corporation (such as keeping the minutes, providing reports, having meetings and so on). If not, the IRS may invalidate the entity and you could face serious tax consequences.
- The salaries must be reasonable for the duties. The IRS really likes to focus on this for audits.