C corporations were the preferred entity structure from the 1940s to the 1980s. This is because these entities provided tax relief to high earners during that period. To fully comprehend its popularity and to understand why it’s lost its fame in recent years, a short history lesson on U.S. tax rates is required.
C corporation tax rates
The top marginal tax rate for individual U.S. taxpayers in the 1970s was 70%, prior to which the marginal rate hovered in the low 90-percentage range between 1952 and 1963. With the all-time high tax rate for individuals occurred during World War II, when the tax rate peaked at 94% in 1944 and 1945 for taxable income exceeding $200,000 ($2.5 million in today’s dollars).
U.S. citizens who would have been subjected to these top marginal tax rates surely would have found a way to avoid paying 70%, 80%, or 90% of their income to Uncle Sam. And that preferred way of sheltering their income in the post-World War II era of the American economy was the good-old C corporation.
From preferred entity structure to a forgotten business type
You may wonder what happened to the popularity of the C corporation today. Well, during the 1950s, when the top individual rate was in the 90 percent range, the top tax rate on traditional C corporations was 52 percent, almost 40 points lower than the top individual income tax rate. President John F. Kennedy lowered the top individual rate to 70 percent in 1963, but there was still a spread of 22 points when compared with the top corporate rate of 48 percent. Then, an expansion in the total number of allowable shareholders in an S corporation and the creation of a new entity called the Limited Liability Corporation decreased the use of C corporations during the early 1980s.
In 1986, the top individual tax rate of 28% finally dipped below the top corporate tax rate of 34%. Wealthy taxpayers who were still sheltering income using C corporations immediately began reporting most of their income on their individual tax returns by flowing business profits through sole proprietorships, S corporations, or LLCs. Between 1986 and 1996, S corporations and LLCs overtook C corporations as the business entity of choice.
As a comparison, in 1958, C corporations and Partnerships (LLCs) numbered roughly 1 million each, with hardly any S corporations in existence. By 2010, C corporations stood at 1.5 million while Partnerships (LLCs) grew to 3.4 million, and S corporations grew to 4.2 million.
With the proliferation of Partnerships and S corporations, C corporations became the forgotten business entity, and then tax reform happened.
The effect of the tax reform bill on C corporations
Just when it looked like S corporations and Partnerships would be the preferred business entity of choice into the indefinite future, President Donald Trump and the U.S. Congress passed the “Tax Cuts and Jobs Act of 2017” in December 2017. This lowered the top corporate tax rate from 35% to 21%, which is 16 points lower than the 2019 top individual rate of 37%.
This may mean that wealthy Americans would want to shift their business income from S corporations and LLCs back to C corporations. but, while the tax reform bill lowered the Federal tax rate to 21 percent, it also made available certain advantages to the specified individual and trust owners of partnership and S corporations with a special 20 percent income deduction. So, it is important to consult with a tax expert should you wish to change your entity structure for tax purposes. You would need to consider various factors to decide which structure would work best for your business.
Forming a C corporation
Both C corporations and S corporations are born the same way, by filing Articles of Incorporation with the state in which you want to conduct business. When Articles of Incorporation (also called Certificate of Incorporation or a corporate charter) are filed with the state, your business officially becomes a legal entity separate from its owners called a “corporation.”
Corporations by default must follow the taxation rules contained in Subchapter C of the Internal Revenue Code, hence the name C corporation. (S corporations are taxed according to Subchapter S of the tax code.)
Think of Articles of Incorporation as an application a business fills out to become a “corporation.” While rare, Articles of Incorporation can be rejected for various reasons.
Once approved by your state, Articles of Incorporation become a matter of public record.
Most states require at least the following information to be included in the Articles of Incorporation:
- Corporate name;
- Business purpose;
- Registered agent;
- Number of authorized shares of stock;
- Share par value;
- Preferred shares;
- Directors; Officers;
- Legal address of the company.
Incorporate your business in any state
Many businesses choose to incorporate in the state where they conduct most of their business or where their headquarters is located. Corporations, however, have the flexibility to file their Articles of Incorporation in any state.
Incorporating in the same state where your business is located is often the cheaper alternative. If you incorporate in a different state, you’ll still need to pay a fee to register your company in the state where your business is located, in addition to paying a fee to the state where the Articles of Incorporation are filed.
Benefits of Delaware C corporations
If you want to file your Articles of Incorporation in a state other than where your business is physically located, Delaware is always a popular choice for several reasons.
- First, the Delaware General Corporation Law offers very flexible terms for how a business can structure its corporation and board members. For example, Delaware permits only one individual to be the sole shareholder or officer of a corporation, while other states mandate a minimum of three people holding positions of officer or director.
- Second, the Delaware Court of Chancery is the most well-known and respected business court in the United States. This court hears a high volume of corporate cases, which means more predictable outcomes where legal advisors can be on the lookout for precedents and rulings on past cases. The court also uses judges instead of juries. If you find yourself involved in corporate litigation in Delaware, your case will be assigned to a judge who is an expert in complex corporate law matters.
- Third, the incorporation process is faster in Delaware than most other states. Delaware also doesn’t require the business to publicly disclose the names of the corporation’s directors or shareholders, which offers an additional layer of privacy.
- Finally, Delaware C corporations are preferred by venture capitalists and investment banks. Venture capital firms and angel investors sometimes require start-ups to be Delaware corporations before funding is provided. According to Delaware’s “Division of Corporations” website, more than 66% of Fortune 500 companies have chosen Delaware as their legal home.
Choosing the right structure for you
Understanding the tax differences between entities is fundamental to your business development process. Your business entity structure directly impacts your tax obligations and should be carefully considered when considering starting a business, or when you’re wanting to change entity structure type.
Fusion CPAs understand the tax implications per entity and can look at our business needs to help you decide on the most suitable entity type for you.
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.