A C corporation is an excellent tool for asset protection and running a business.
Best Legal Protections for Assets
Of all the entities it is my personal favorite because it has some of the best legal protections for assets. Part of this reason, is that it is so long-standing and time-tested (A C corp is probably 2nd only to “qualified retirement accounts” for acting as a fort for your assets) and you can feel secure in how the courts will likely rule.
Some form of corporations existed for running businesses such as when Columbus sailed to America to protect the Queen’s assets from injuries and deaths by the ship workers on the journey.
It is believed that corporations existed in Roman times. In any event, they are very old, time-tested and there are many court precedents and how the judges and appeal’s courts will rule on corporations. Rich people own corporations. Successful businesses are almost always corporations.
IBM, Microsoft, Wells Fargo, Gulfstream, General Motors, Philip Morris, Brookshire Hathaway, General Electric, Walmart, Sears, Pizza Hut/Taco Bell/Kentucky fried chicken, Wendy’s, Burger King, Ford, Exxon, Volkswagen, Toyota, CVS, State Farm, Prudential, AIG, GEICO, Allstate, BMW, Nestlé’s, Cosco, Fiat, Bass Pro shop, Nissan, Honda, Bank of America, Wells Fargo, SunTrust Bank, Hewlett-Packard, virtually every successful company you can think of operates as a C corporation.
Shouldn’t we imitate and copy successful businesses? We don’t go to the gym and seek a person who is out of shape to teach us fitness. Likewise, we should watch successful people and businesses and follow the same time-tested strategies. The asset protection and tax laws for corporations apply to all corporations equally. The government, courts and the IRS cannot give big companies preferential treatment without giving the same treatment to small and family-run corporations.
These wealthy companies, individuals and entities invest a lot of money in lobbyist and politicians in getting special interest and favorable tax laws and asset protection laws through the Legislature.
Personal Liability Exposure: Personal Injury Lawyer GA
With personal liability exposure, less available tax deductions, higher tax rates; it makes no sense to do business as a sole proprietor or an individual.
A C corporation is a stand-alone entity, an artificial person. It has its own tax ID number, it can sue and be sued. As long as you treat it as a business, don’t commingle funds and run it properly, the courts will also treat it separately from you as an individual. For instance if the C corporation is sued a judgment can be obtained against the corporation and its assets, but not against the individual shareholders and officers (unless they personally act in their individual capacity and are personally negligent).
The fact that a C corporation is the “work horse” of a business is why you never want to own appreciating asset such as real estate in the corporate name. For purposes of depreciation and write offs it’s okay for you to own depreciating assets such as cars/trucks/vehicles, cellphones, computers, office furniture, trade equipment and such. However, if the C corporation runs a business such as a trucking business, lawn service, fishing charters or other businesses with very expensive equipment; it is recommended to have a separate entity to own the equipment and lease it back to the C corporation. If you had a moving company and used Hertz trucks, they can’t take the trucks if you or one of your drivers is in a wreck. Instead of Hertz the leasing company can be a separate company that you own.
I repeat, never own real estate in a C corporation. The only time there is an exception to that is if you are buying, rehabbing and flipping houses and there’s a lot more you need to learn before you even use a C corporation in that exception. To do otherwise could result in double or triple taxation.
In addition a C corporation has a different tax level than an individual, it is generally taxed at a lower rate.
A C corporation receives preferential treatment for purposes of taxes in that it receives many more deductions than almost every other type of entity. Great advantages to a corporation include the fact that you can have your own pension plan (my preferences is a 401(k)); of course you can only contribute to a retirement plan if you pay yourself a salary.
Along with paying a salary comes responsibilities of a payroll taxes with proper withholdings of federal, State, Social Security, Medicare and unemployment taxes. Of course this can easily be delegated to a CPA or payroll service. Just like any business you will need to pay these taxes either weekly, monthly, or quarterly depending on the size and amount of your payroll.
C corporations can also pay for many employee benefits, including health insurance, awards, life insurance, long-term care insurance, out-of-pocket and medical deductibles (as long as you have a qualified/written medical plan).
In my opinion one of the best uses of the C corporation is for individuals or couples who have a W-2 job to cover their basic living expenses and they want to have a side business that is separate, stand-alone, has its own tax rate and provides them with excellent perks and benefits.
- An individual couple who own rental real estate in LLCs or subchapter S corporations (asset protection) and use a C corporation for the active business of property management, marketing, etc.
- A stay at home mom, opening an in home day care.
- A police officer, teacher, fireman seeking to operate a small business or have a side job, who wants to have asset protection and prevent being taxed at their “day job” tax rates.
- A separate business from your day job like a lawn care service, property management or real estate license. These might also lend themselves (being service businesses) to be in an S corporation which is a flow-through company for tax purposes. A C corporation is superior to an S corporation in that you get a few more deductions like life insurance and some additional medical deduction benefits. However an S corporation can work quite well for an individual who provide services in the profits or losses flow down to them and requires much less formalities. As has already been discussed an S corporation also can pay dividends at a lower tax rate than a C corporation. You just have to know the distinctions and decide which is better for you. There is always a one time election that you can convert a C to an S and/or an S to a C.
- A weekend or evening business which could include photography, painting, travel books/blogs, fishing charters, golf / tennis / yoga or karate lessons. Consider as a business any current hobby or potential business that you really love and have passion for. This could range from making clothes, knitting, writing and publishing books, travel, SCUBA diving, cookbooks, to children’s books. Virtually anything you have a passion for can be turned into an income producing business. It’s okay if you have multiple businesses that each sometimes make money and sometimes lose money.
- One example is a couple that I met who traveled on cruise ships. They took photographs of items in shops and posted them for sale on their webpage. This business allows them to travel, have a business, pursue a profit and receive many deductions.
- I know another couple who like to travel in their RV. Each week they would stop at a local festival (North Georgia Mountains and coastal beaches) and sell the wife’s paintings. They were getting to travel, fulfill her passion of painting, sell the paintings for profit, deduct their travel expenses, and see whatever part of the country they wanted to travel to. This could be done with almost any product that would allow you have a business that involved travel and deductions. Clearly you have to show a sincere effort to make a profit. You would need to meet all the formalities of a business. Examples are business license, business cards, letterhead, some sort of marketing, separate checking account, webpage, corporate meetings, etc.
- These could include any hobby or passion that you have that you want to make into a business. You need a sincere effort to turn it into a profitable business. A good idea is for you and your spouse to each have your own business or even a joint business that you could pursue profits, deductions and write offs.
Perils of the C corporation
Having stated some of the positive aspects of a C corporation; they also carry with them responsibilities and sometimes negative matters. You need to be aware of these and consider them in weighing how you conduct your business and what type of entities you use.
Since a C corporation is a stand-alone entity (which is great for asset protection) it can be challenging on how you get money out of the corporation while minimizing your tax exposure. You can use profits for deductions, benefits, perks, salaries in contribution to retirement accounts. However, when you take money out of his salary you must pay payroll taxes. This includes federal, state, Medicare, FICA/Social Security and unemployment taxes. You are required to keep separate accounting books and file tax returns. You are required to hold annual meetings. These all take time. Of course you can hold the meetings out of town and deduct travel.
One business strategy that owners of C corporations often use is to spend all of the money in the corporation for deductible benefits, equipment, mileage reimbursement, health insurance, life insurance in other items and services that they can pay with pretax dollars; this often results in zeroing out the corporation before year end so that no corporate taxes will be owed. As long as they are legitimate expenses and deductions this is perfectly allowable.
This often means that the shareholders do not receive a salary or dividends (I recommend against dividends with a C corporation because they are not deductible to the corporation and they are taxable to the individual – it is far superior just to draw salary) nor do the officers or employees draw a salary. Not having a salary or any earned income can create its own problems. You need to fully consider these matters before eliminating a salaried job.
A C corporation works well for many owners because they may not need the income, or they may have a W-2 income from a different source, have unearned income from a different source such as stocks, bonds, real estate, or maybe has a spouse that earns income. However if the C corporation is your sole means of income not drawing a salary can have several negative effects, including:
1. Social Security and Medicare. If you are not drawing a paycheck and you have no Social Security or Medicare withholdings this could affect your ability to receive Social Security income and what level of income you receive under retirement or Social Security disability. If you don’t pay in you may not be able to draw it or if you pay in too low of an amount your income benefits may be lower. You need to discuss this matter with your CPA and a Social Security attorney to determine the rules of what quarters of income are used to calculate your benefits.
The negative aspects of converting an “employment” to an independent contractor and running a corporation in this manner would be the same for any income based benefits that you might seek. As already mentioned these include Social Security income, Social Security Disability and other income based things may affect your benefits for example for private disability insurance. Also if you are not an “employee “, you will not likely be eligible for unemployment should you lose your job/contract.
If you are an employee and your employer compensates you by payroll and you convert to an independent contractor; this will affect how you are taxed on Social Security and Medicare. As an employee you pay combined 7.65% Social Security and Medicare and your employer pays a matching 7.65%. If you become an independent contractor any taxable income you will have to pay a “self-employment tax” or in other words the employee and the employers 7.65% of payroll taxes. This means that you will pay 15.3% of your income in Social Security and Medicare as an independent contractor as opposed only 7.65% as an employee. As an independent contractor you will likely receive a much lower net / taxable salary and the savings of a C corporation may offset that extra tax. One way to offset this potential disadvantage is if you can have your corporation receiving income for separate services such as management, marketing or as an independent contractor; all the while still drawing a salary from an outside source.
This can be the best of both worlds because you are splitting your income into lower tax rates while still receiving benefits as an employee of a third-party company and the benefits of being a stockholder and officer of your own corporation. The risk here is on your current employer being able to make the argument that they are not avoiding payroll taxes by using the strategy. The counter to this is for example your job salary and W-2 income is for managing the business. A lower salary may be justified because you are spending fewer hours providing that particular service. And your employer has hired an outside company (you or C Corporation) to provide services for marketing such as flyers, building and maintaining webpage, promotions, etc. The employer hired your company because of your experience and history in the business.
Let me inject here; my message to you is to never lie, cheat, steal or hide income – show all income and have a reasonable basis for any business decision (such as asset protection) and operate your business as a business. If you do that the worst that can happen is that you get audited and something gets disallowed. You should always do your own due diligence.
I recommend you look at www.irs.gov for the rules that apply. Then you simply download and print those and keep them in your corporate file. Then you always have a reasonable argument for any challenge by the IRS. There is nothing wrong with structuring your business affair sin entities and in a manner that maximizes your profits in minimizes your tax exposure.
Tax avoidance is the legal usage of the tax regime to one’s own advantage, to reduce the amount of tax that is payable by means that are within the law. Tax sheltering is very similar, and tax havens are jurisdictions which facilitate reduced taxes. The term tax mitigation is sometimes used; its original use was by tax advisers as an alternative to the pejorative term tax evasion. “Tax aggressive” strategies fall into the grey area between commonplace and well-accepted tax avoidance (such as purchasing municipal bonds in the United States) and evasion. However, the uses of these terms vary.
Laws known as a General Anti-Avoidance Rule (GAAR) statutes which prohibit “tax aggressive” avoidance have been passed in several developed countries including the United States (since 2010, Canada, Australia, New Zealand, South Africa, Norway and Hong Kong. In addition, judicial doctrines have accomplished the similar purpose, notably in the United States through the “business purpose” and “economic substance” doctrines established in Gregory v. Helvering and in the UK through the Ramsay case. Though the specifics may vary according to jurisdiction, these rules invalidate tax avoidance which is technically legal but not for a business purpose or in violation of the spirit of the tax code. Related terms for tax avoidance include tax planning and tax sheltering.
The term avoidance has also been used in the tax regulations of some jurisdictions to distinguish tax avoidance foreseen by the legislators from tax avoidance which exploits loopholes in the law such as like-kind exchanges. The United States Supreme Court has stated that “The legal right of an individual to decrease the amount of what would otherwise be his taxes or altogether avoid them, by means which the law permits, cannot be doubted.”
Tax evasion, on the other hand, is the general term for efforts by individuals, corporations, trusts and other entities to evade taxes by illegal means. Both tax avoidance and evasion can be viewed as forms of tax noncompliance, as they describe a range of activities that are unfavorable to a state’s tax system.
2. Double taxation. Each year you should look at the tax schedules for individuals vs. the tax schedule for C corporations. Generally the rates are more favorable for C corporations than individuals.
So at year-end if you had some profits left over in your corporation, that you intended to pay taxes on, it likely would be cheaper if you left it in the corporation and paid the taxes on it. This would allow the funds to be available in after-tax dollars for your use by the corporation. However if you needed these funds personally to live off of (even though it would potentially be taxed higher) you may be better off taking the money out of the corporation as a salary. You should do one or the other but not both. In other words if you left it in the corporation and it was taxed and then you later drew it out as a salary and it was taxed again that would be an example of double taxation. This paragraph is to serve as an illustration. Often times some cash can to be retained in the corporation and not taxedt.
One example would be if the Corporation had some depreciation loses on property or other assets. The losses would offset profits. And under tax rules some businesses may be allowed to retain some funds that are not taxed. You would need to consult your tax expert on this matter. This just once again proves that there are exceptions to almost every rule.
3. Credit and bank loans. If you structure your entities such that many of your benefits are paid with pretax dollars and this strategy lowers the amount of your income; this could be detrimental when making applications for credit cards, loans and mortgages. Traditional institutions usually base their decisions on earned income and ability to pay for making loans. Banks, mortgage companies and other lenders usually are not sophisticated enough to understand entity structuring and they have basic traditional guidelines they must follow. Clearly if you lower your income you can lower your ability to borrow money.
As mentioned earlier is never a good idea to pay yourself with a dividend with a C corporation. It is double taxed because a corporation can’t deduct it and will pay taxes on it and you will also pay taxes on receiving. I suggest that you should never pay dividends in a C corporation. As a side note this is different in an S corporation since an S corporation is not a stand-alone and the taxes for profit and losses flow directly to you as the owner, the Internal Revenue Code allows you to pay dividends which are deductible to the S corporation (even though this is taxable to you as an individual), it is not considered “earned” income so you pay no Social Security and Medicare which save you 15.3% undercurrent tax rates. You can only do this with an S corporation after you’ve already paid yourself “a reasonable salary”.
A summary of some benefits of a C corporation are:
- Your corporation spends all of its income on deductible equipment (see 172 and 179 under IRC on IRS webpage), employee benefits and perks and has little or no money left to be taxed.
- You can have multiple entities in which you split income or stagger the years, thus lowering your tax liability.
- Your company pays you and family members as stockholders officers and employees salaries, benefits, health coverage, perks, contributes a retirement plan, etc.
There are positive and negative effects (benefits and detriments) to all choices in life. It is up to each of us to determine what is best for us individually.