The business structure that an entrepreneur chooses for his or her business has both legal and tax implications. This series of articles will be addressing the tax implications of various business structures.[1]
C Corporations are generally the most complex; tax-wise and administratively. A C Corporation “is an independent legal entity owned by shareholders. This means that the corporation itself, not the shareholder that own it, is held legally liable for the actions and debts the business incurs.”[2]
Since the corporation is a separate legal entity, this results in two levels of taxation; one for the owner (shareholder) and one for the corporation. If the corporation distributed its earnings as dividends to the shareholder, double taxation would apply with a tax rates as high as 39.6% individual and 35-39% corporate.
C Corporations are not necessarily the ideal form of business structure for smaller companies. They are generally recommended for larger companies with numerous shareholders.
But part of the reason the corporate form developed was in response to unincorporated businesses (sole proprietorships/partnerships) needing some form of legal protection. The resulting double taxation caused other business structures (such as S Corporations, LLCs, etc…) to develop either federally or at the state level.
Interestingly, other countries have the same issues, but their solutions differ. For example, Canada has the corporate form also. Instead of developing numerous business structures[3], Canada counteracted the double taxation issue by changing the tax rates on dividends.
In Canada, when an individual receives a dividend, they “gross up” the dividend on their individual tax returns, and then receive a tax credit for part of the gross up. Canadian corporations also receive several tax credits depending upon their ownership and size.
The net effect is that the tax paid overall on the dividend distribution can be approximately the same as if the individual earned this income personally.
So instead of creating the myriad of business structures that the U.S. has, Canada adjusts the tax rates on the dividends so that the tax paid is approximately the same as an unincorporated business.
Which seems simpler to you?
If you have any U.S. (or Canadian!) tax questions, feel free to contact CPA WorldTax at taxinfo@cpaworldtaxllc.com.
[1] If you have questions on legal implications, please discuss with your attorney.
[2] https://www.sba.gov/starting-business/choose-your-business-structure/corporation [accessed Nov 4 2016]. Discuss any legal implications with your attorney.
[3] Canada does have a few business structures beyond the corporation but they are beyond the scope of this article