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	Steven D. Strauss Author of The Small Business Bible
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	Joe Kennedy Author of The Small Business Owner's Manual
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	Tom Severance Author of Business Start-Up Guide
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	Stephanie Chandler Author of The Business Startup Checklist & Planning Guide
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C-Corporation

Year-End

An incorporated small business may keep an accounting system and report taxes based upon dates that make sense to that business rather than follow the traditional January 1 -- December 31 tax year or the owner’s personal tax year. For example, a ski resort may find that it makes sense to close the year when winter is over, say on April 30. Things are not so busy then, and interested parties will find the financial statements and tax returns more meaningful. If the year closed in the middle of winter (December 31), purveyors of financial statements would not know how the season really turned out.

Double Taxation

A drawback to the corporate form of ownership is the widely debated anomaly known as double taxation. Here, the federal government (and most states) charge corporations a portion of their earnings for income taxes. After the income taxes are paid, the business may declare that some of the remaining after-tax earnings are payable to owners as dividends. Unfortunately, dividends may not be deducted by the corporation as a business expense, so corporate taxable income is higher by this amount and corporate taxes do not benefit from the dividend declaration. However, after the dividends are paid, the government steps in again and asks you (as an individual) to report those dividends as income on your personal tax return and pay a portion as part of your income taxes.

For this reason, small businesses do not normally declare dividends. However, this declaration may be forced if the IRS accuses a firm of holding excess retained earnings. In that case, the firm is forced to declare dividends, which leads to paying double taxes.

In reality, however, double taxation can be avoided though careful tax planning. Normally, this is accomplished when the small business corporation pays compensation (salaries, bonuses, commissions, fees) to owners before the tax year ends. Thus, the expense is out the door before taxes are calculated. As business expenses go up, taxable income goes down, so fewer taxes are due. On the other hand, payroll taxes are due on the compensation received by the small business owner. In summary, corporate income taxes decreaseâ€”and personal income taxes and payroll taxes increaseâ€”due to the extra compensation. No general rule governs this particular issue. Small business owners and their CPAs must compute this annually as year-end approaches.

There are, however, limits to this device. The IRS requires that small business owners may not be paid compensation and avoid taxes beyond those amounts normally paid in specific industries and locations.

Perpetual Existence

Unlike sole proprietorships, partnerships or even professional service corporations, C-Corps. live on until the owners decide to terminate or sell off the business, or upon bankruptcy. Despite changes in management or even the death of an owner, corporations enjoy an independent and continuing legal existence. As a result, employees, creditors, vendors, clients and other parties may be impressed by this fact and feel more confident about working with your small business. Outside parties working with fast-growing businesses especially appreciate this corporate characteristic.

Formality

There’s no doubt about it: The corporate form of small business ownership commands at least a little more respect from everyone. Incorporating is one of the best ways to tell the world that your business is here, and here to stay. Your company is now ready to enter into agreements and relationships that are normally afforded only to corporations (for example, a service contract with a big company, or a bank loan). This benefit is intangible and impossible to quantify, but it will help distinguish your company from competitors. In the end, many small businesses incorporate for this reason, regardless of the tax consequences.

Access to Capital and Big Deals

The corporate form of business ownership is custom-designed to receive capital through investment and the sale of a wide variety of equity devices; through debt instruments such as unsecured lines of credit, collateralized loans, secured promissory notes, and debentures; or by landing a big corporate client. When the situation requires special features (such as allowing debt to be converted into shares of stock; conferring voting rights on lenders; providing for preferred stock conversion to common stock, stock options for management, indemnification of large clients, etc.), it is easier to write these into corp.-to-corp. agreements than into any other form of business ownership. In the real world, small businesses requiring access to big-time capital need to be incorporated.

Paperwork and Fees

Some small business owners feel that the corporate form of business ownership requires more administration as well as attention to deadlines and details. For example, California corporations are required each year to announce and hold at least one shareholders’ meeting, (re)elect the officers and directors, and convene meetings to discuss special situations, report decisions, or grant special authority (for example, “Owen Owener is hereby granted the authority to open a new business checking account at Corner Bank”). California corporations must also file an annual Statement of Information with the secretary of state ($25 fee); file corporate income tax returns; pay and file documentation for state and federal payroll taxes at least quarterly; pay a minimum annual state income tax of $800, even if the year was a loss; and be aware of many other potential events requiring time, work, and fees. A good accounting system is required to handle these obligations.

The counterargument here is that this is not a great price to pay, considering the benefits of corporate ownership. This is what is required if a small business wants to play in the big leagues--and what kind of business these days cannot afford Quickbooks or similar accounting software?

One disadvantage is the $1,000 to $3,000 fee normally charged by attorneys to set up a new corporation properly. This fee can be avoided, however, if the situation is straightforward (incorporating a new small business with one owner) and the owner has the time and patience to read and follow instructions carefully. Moreover, many of the forms dealing with corporate formalities can be found easily on the Internet and at office supply stores, or may be borrowed from colleagues.

Tax Treatment

In addition to the tax issues described previously, note that the IRS recognizes corporations as entities separate and independent from their owners. Accordingly, corporations must file separate federal and state income tax returns. Federal returns are submitted on IRS Form 1120S (Corporation Income Tax Return). Apart from normal income taxes attributable to dividends received, there are no income tax consequences for corporate shareholders until shares are sold and a gain or loss is recognized. In that case, the gain or loss is treated the same as any other security transaction.