The Truth About Double Taxation and C Corporations


3-30-11

Most people have one of two opinions about C Corporations: They love them or they hate them.

If you love them, make sure you’re aware of the potential traps of C Corporations. They work great in the right circumstances and can be disastrous if you use them incorrectly.

But today I want to talk about one of the myths about C Corporations. I keep running into people who quickly say the dreaded two words when it comes to C Corporations as to a reason why they shouldn’t have them.

Those two words are “double taxation.” It’s the most commonly given reason for not taking advantage of the special tax breaks and benefits you can get with a C Corporation. But the reality is that there are reasons why you shouldn’t have a C Corporation, but double taxation is rarely one of them.

The term ‘double taxation’ refers to what happens when a C Corporation pays out a dividend. The dividend is paid from after tax income of the Corporation. It is not deductible. So tax is paid once. Then the owner has to pay tax on the dividend income that is received.

Salary is not subject to double taxation. That’s because it is paid out of before taxable income. It IS a deduction for the corporation. So even though it’s taxable to the recipient, it’s a deduction for the corp so there is only tax once.

Benefits are not subject to double taxation. In most cases, the benefits are a deduction for the corporation plus they are not taxable to the recipient. So it’s the best of all words – no tax for anybody.
The only double taxation a C Corporation has occurs when dividends are paid.

If you want to avoid double taxation, the best strategy is to set up your C Corporation so you don’t ever have to pay out dividends.


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5 Comments so far:


On December 3rd, 2012 | 11:52 pm
John said:

What would you say are the reasons for not setting up a company as a C corp?

Thanks,
John


On December 11th, 2012 | 12:58 pm
Megan Hughes said:

Hi John,

The reasons I see are:

1. Mismatch in tax treatment. If appreciating assets go into a C Corporation, they come out at a much higher tax rate than if they were in a flow-through entity.

2. Higher taxes & costs: There are quarterly tax filings to be done with C Corporations and quarterly estimated tax payments. Plus you’ve got the C Corporation tax return, and maintenance fees. Some of those you’d have in any event, but not necessarily all of them. If you aren’t getting a financial benefit from being in a C Corp, or an LLC-C, then I think it’s easier to operate through a flow-through entity.


On December 11th, 2012 | 1:42 pm
John said:

Thanks Megan! As of now, it seems like I don’t make enough to have a C-Corp.


On April 26th, 2013 | 3:08 pm
Carol said:

Aren’t you double-taxed though when the C Corp is liquidated? Is there any way around this? The C Corp holds real estate and mineral interests. Can you pay it out as a salary to the ( 10) shareholders?


On May 1st, 2013 | 1:30 am
Diane Kennedy said:

Carol, if there are assets that are distributed when the corporation is liquidated, there is a liquidation dividend. Usually, a tax strategy for dissolving a C Corp involves getting the assets out of the company first.

One of the unspoken rules for C Corp is that you don’t ever put appreciating assets inside a C Corp. If you have some in there, and they have appreciated, you can elect S Corp status and then wait through the mandatory period (was 10 years, changed to 5 years in some circumstances). You can then later distribute like an S Corporation.

You could also pay out assets like salary, so it is deductible.

There are a lot of options here. Think through the possibilities and consequences with a tax pro who is experienced with C Corps. I suspect there is a way to accomplish what you want without having to create liquidating dividends.



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