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A corporation is considered a separate legal entity apart from its owning shareholders.
Shareholders generally have no personal liability for the obligations (debts) of the corporation, assuming the necessary corporate formalities are followed. Failure to treat the corporation as a separate legal entity (such as using the corporate check book for personal items, etc.) may allow a creditors to "pierce the corporate veil" and hold shareholders personally liable.

Entity Level Taxes

An Internal Revenue Code “C corporation" is subject to federal income tax on its net taxable income as follows:

Taxable Income                        Tax Rate

Zero to 50,000                              15%
50,000 to 75,000                          25%
75,000 to 100,000                        34%
100,000 to 335,000                      39%
335,000 to 10,000,000                 34%
10,000,000 to 15,000,000            35%
15,000,000 to 18,333,333            38%
18,333,333 plus                             35%

Earnings of the corporation (net of the corporate level tax) may be passed to shareholders in the form of dividends which are then subject to tax on their individual Form 1040 income tax returns. As you may have guessed this double taxation is a major disadvantage of choosing a “regular” C corporation as a business entity choice.

Closely held corporations where shareholders are also employees of the corporation may be able to minimize this double tax effect by increasing compensation (W-2 wages) and thus reducing corporate level taxable income.

An example might help; assume the corporation has one shareholder with an average tax rate of 28% and $300,000 in corporate taxable income that is paid out in dividend income. Total corporate and personal taxes total $156,180 (net cash flow of 143,820). Now assume the $300,000 is paid to the employee/shareholder as W-2 Wages. Corporate tax is now -0- and personal income tax paid is $84,000 (net cash flow of 216,000). Problem solved right? Unfortunately, the IRS has developed a small cottage industry around avoiding our little tax saving example. In closely held companies especially the IRS may limit deductible compensation to what it deems “reasonable compensation”. Any amount paid in excess of “reasonable compensation” is not deductible to the corporation and is treated as dividend income to the shareholder.

Let’s explore our little example further. Assume we have a very profitable corporation that may push the bounds of “reasonable compensation” if the earnings were paid to the shareholder/employee as W-2 wages. In order to avoid the double tax, the corporation decides to pay the corporate tax and NOT pay out the earnings. Problem solved (again) right? As you may have guessed the answer is still no. This time it is the “accumulated earnings tax” that may kick in to penalize the corporation for not paying its double tax.

Why Choose a C Corp?

The problems of “excessive compensation” and “accumulated earrings tax” can generally be minimized with proper tax planning. With the potential tax disadvantages noted above what are some reasons why a “regular” C corporation may be a good entity choice? A regular C corporation may have more than one class of stock such as preferred stock or non voting stock. This can be of supreme importance in family business succession planning. C corporations have no restriction on the number of shareholders. By contrast, an S corporation may only have one class of stock and is limited to a maximum of 75 shareholders. There are also other restrictions on the types of shareholders that may invest in an S corporation.

Note: In the state of Texas, a corporation may have as few as one shareholder and one director who may be the same individual. The corporation must have a president, secretary, and treasurer who may be the same individual. A corporation must first file its Articles of Incorporation with the Texas Secretary of State and is subject to Texas Franchise Tax.