The C Corporation is a regular corporation that is treated as a separate taxable entity. It is usually regulated by the states, and it is established by filing the incorporation documents with the Secretary of State offices with payment of an incorporation fee.
Owners of a C corporation are known as shareholders or stockholders. Owners of a C corporation will be shielded from being personally liable for corporations’ debts and liabilities. Also, C corporation does not have any limitation on the number of owners and the type of owners. Ownership of a C corporation is easily transferrable through a stock sale. One possible restriction is that many small businesses will include a right of first refusal in the shareholder agreement to allow the company to have the first chance to buy the stocks back if the shareholder want to sell them.
In terms of control of the business, the default rule benefits the majority shareholder. Majority shareholder elects the board of directors, which makes decisions on nearly all major business operation issues. Some states require a supermajority vote on certain types of corporate actions, such as sell of all or majority assets of the business, or merger and acquisitions, but in most situations, a majority vote is all it needs. However, these default rules can be changed by putting a special agreement at the time of incorporation.
There are usually two types of stocks that a C corporation could issue: common stocks and preferred stocks. Common stock is most common type of stocks that a corporation could issue. It entitles shareholders of the company share profits of the corporation through dividends and capital appreciation. Common stockholders are also usually entitled to voting rights proportionate to the number of shares they own. Common stockholders also often enjoy preemptive rights, which means if the company were to issue new stocks, the common stockholders who enjoys preemptive rights have the choice of purchase new stocks to maintain the proportional ownership/voting rights of the company. Common stockholders are the last one in line to get paid in terms of dividends and liquidation, however, what most investors in common stocks are looking for is a much higher capital gain in long term price appreciation.
Preferred stocks are a special type of stock that have a few features that are not shared by common stock. Preferred stocks usually have no voting rights, but in some situation, preferred stocks would be associated with overweighed voting power. Some of these features include preference in issuing dividends (company pays dividends to preferred stockholders before it pays common stockholders), preference in liquidation (in the event of bankruptcy, preferred stockholders have a claim in the company assets before the common stockholders). However, preferred stockholders usually do not have voting rights. Preferred stocks are also callable at any time by the corporation. This means that the corporation can choose to purchase back the preferred stock at any time the corporation chooses to, but usually with a favorable price. Preferred stocks often carry a fixed amount of dividend payments. It can be cumulative or non-cumulative. Cumulative preferred stocks give the stockholders the right to cumulate dividend payments when they are not made due to the financial situation of the corporation. Non-cumulative means the owners do not have right to receive skipped dividends. Preferred stocks can also be convertible back to a certain amount of shares of common stock.
Corporation can use the issuance of different classes of stocks as a strategy to maintain control within a group of shareholders. For instance, Ford family controls all the shares of the company’s Class B preferred stocks. Class B shares constitutes less than 2% of the company’s outstanding shares, but hold 40% of the voting power. This way, the company can issue as many as common stock as they need to raise capital, but still have the power to make vital decisions for the company. When Class B shares are sold outside the company, they would convert back to common shares. Similarly, when the Chinese E-commerce giant JD.com went public, the CEO and founder of the company, Qiangdong Liu also used a dual share class structure to ensure his control of the company. All his original shares of the company were converted to Class B shares that grants him 20 votes for each share Class B share he owned, compare to 1 vote per share for Class A shares. After the IPO, Mr. Liu would still own 83.7% of the voting power of the company.
Even though owners of the corporation are the shareholders, they are not responsible for overseeing the activities of the corporation. A body named the board of directors elected by shareholders is responsible for the governance of the corporation and is the highest authority of management. The scope of the board’s authority, responsibilities and duties is usually specified in the bylaws.
Some most common board duties include appoint executives and officers for the corporation, issuing dividends, deciding policies regarding management of the corporation, determining the mission of the corporation and making sure that the corporation stays on task. Board members own fiduciary duties to the shareholders. Its ultimate goal is to protect and enhance the shareholders’ investment in the corporation.
Board members usually also enjoy limited liabilities and will be protected from personal liabilities in connection with their duties on the board. This is usually done by putting in an indemnification provision in the bylaws of the corporation, stating that the members will be reimbursed for any expenses of liabilities occurred while they are performing their roles as board member. This protection can even extend to cover personal liabilities incurred by lawsuit filed by shareholders of the company. However, the indemnification provision usually don’t cover behavior that is bad faith, intentional or fraudulent.
C corporation’s income and revenue will be taxed at the corporation’s level, and then when the corporation issues dividends to the shareholders, the income will be taxed again at the personal income tax level. This is called double taxation. Most of the times, a startup business or a privately-held small business will try to avoid double taxation by not choosing the C corporation entity at all. However, this is not always true. Sometimes, corporation might provide more tax benefits than a pass-through entity such as partnership or Limited Liability Company.
One of the tax benefits of C Corporation is the favorable low end rate. This is only available for businesses that are not qualifies personal service corporations. For the corporations that can enjoy this benefit, the first $50,000 taxable income of a C corporation is subject to 15 percent tax rate, the income between $50,000 and $75,000 is subject to 25 percent. Beyond $75,000, the rate jumps to 34%, and the advantage starts to disappear. However, for a small business owner, the save on the first $75,000 taxable income can be substantial. More so when the taxable income of the corporation can be bailed out by paying reasonable salaries to the owners as employees of the corporation, not as dividends. Moreover, pass-through entity choices might lose their attraction if the campaign to increase high-end personal income tax rate succeeds. For instance, if the high-end personal income tax rate rises to 45%, as some have suggested, while the high end C corporation tax rate remains at 34%-35%, it might be enough to give up considerations for pass-through entities all along.
Second, if the plan for the business owners is to go public at the first opportunity presented, then using the C corporation entity is a requirement. Because there is no limitation on how many shareholders there can be or who are the shareholders.
Finally, sometimes owners of the business just prefer to have complete separation from the business and keep their personal tax matters as simple and clean as possible. The possibility of subjecting their personal tax return to the accounting and auditing of a business entity is just too risky or undesirable, especially when the owners do not have much control of the management of the business.
The incorporation process varies from the state to state. The first thing business owners need to decide is which state they want the business to be established in. Usually the process involves filing with the appropriate state authorities, paying the required amount of incorporation fees, and provide the required organizational documents.
Some of the key organizational documents, some of them mandated by statutes, some of them conventional, include:
Articles of Incorporation: This is the document that establish the existence of the corporation when it is filed and recorded. It usually contains information such as the name of the corporation, the register agent, the registered office, the nature and purpose of the business, the shares of stock the corporation is authorized to issue, the types of stocks the corporation is authorized to issue, the initial officers or directors, and signature of the incorporators.
Bylaw: A by-law is a set of rules established by the corporation itself to regulate the operation and management of the corporation. Some of the key provisions include the roles and duties of the shareholders, qualifications of board members, election and removal of a director, size of the board, term of board members, procedures for calling and holding meetings, annual meeting time and location, election of fiscal year, key contracts approval, indemnification provisions, share transfer restrictions, tax elections and procedures to amend the bylaw.
Directors’ Resolutions: this is a document that documents a corporate action, as it is approved or authorized by the board of directors. Some directors’ resolutions are important to the start-up of a business, such as approving the articles of incorporation, adopting the bylaws, electing the officers, authorizing issuance of stocks, and ratifying pre-incorporation business transactions etc. A resolution can either be a written consent signed by all members or minutes of a meeting where the board members agreed upon the resolutions.
Stock Certificate: This is a legal document issued to the shareholders that certifies ownership of a specified amount of shares of the corporation. It includes information such as when is the certificate issued and to whom the certificate is issued. A physical copy of stock certificate is no longer required in the US, electronic registration is sufficient.
For more information about Starting Your Business Entities, please click on one of the following topics below: