C Corporations: An Introduction

What makes a C corporation different

Every other way of organizing a small business — a sole proprietorship, a partnership, an S corporation, an LLC taxed as any of those — is a pass-through. The business files a return, but the profit lands on the owners’ personal returns and is taxed there. The business itself pays no income tax.

A C corporation is a separate taxpayer. It files its own return, Form 1120, and pays its own tax on its own profit at a flat 21%. The owners are not taxed on that profit. They are taxed only on what the corporation actually pays them: salary, if they work for it, and dividends, if it distributes earnings.

That separation is the whole story. Everything good about a C corporation and everything bad about it follows from the fact that the corporation and its owners are two different taxpayers.

The two layers of tax

Suppose a corporation earns $100,000 after paying its owner a reasonable salary. The corporation pays $21,000 in federal tax. If it then pays out the remaining $79,000 as a dividend, the owner pays tax on the dividend — 15% for most people, 20% at the top, plus the 3.8% net investment income tax above $200,000 of income ($250,000 married). Call it $15,000 more. Of the original $100,000, the owner keeps something like $64,000.

The same $100,000 earned in an S corporation is taxed once, on the owner’s personal return, at the owner’s own rate — and may qualify for the 20% qualified business income deduction on top of that. For most small business owners that works out to less tax than the two layers, sometimes a good deal less.

This is the double taxation you have heard about. It is real, and it is the main reason most small businesses are not C corporations.

A side-by-side

When a C corporation is the right answer

There are real reasons to choose one. They tend to apply to businesses that are growing fast, raising money, or keeping their profit inside the company rather than paying it out.

You are keeping the money in the business

Double taxation only bites when profit is paid out. A business that reinvests its earnings — buying equipment, hiring, building inventory — pays 21% and nothing more, which is lower than the top personal rates. Owners of a pass-through pay tax on the profit whether or not they take it out. There is a limit: a corporation that piles up cash with no business reason for it can be hit with a separate 20% accumulated earnings tax, generally once retained earnings pass $250,000 ($150,000 for professional service firms).

You plan to take on investors

Venture capital funds, angel investors and anyone issuing stock options will almost always want a C corporation. S corporations cannot have entity investors, foreign investors, or more than one class of stock, which rules out preferred shares. If outside money is in the plan, the C corporation is usually decided for you.

You may sell the company one day

This is the big one, and it is better than it used to be. Qualified small business stock under Section 1202 lets the owner of a C corporation exclude a large part — often all — of the gain when the stock is sold, up to a cap of $15 million or more per shareholder (ten times the stock’s basis, if that is more), for stock issued after July 4, 2025; the cap is $10 million for older stock. The company’s gross assets must be $75 million or less when the stock is issued ($50 million for older stock), and the exclusion is 50% after three years, 75% after four, and 100% after five. The company has to be a C corporation from the start, under a size limit, in an active business other than a listed set of service fields, and the stock has to be held several years. For stock issued after July 4, 2025, the exclusion phases in at three years and is complete at five. A founder who sells for several million dollars and pays no federal tax on it is not a fantasy; it is this provision working as designed. It is also the reason this decision is worth making correctly at the start, since the clock runs from the day the stock is issued.

You want the cash method and the full capital loss

Two smaller advantages. A C corporation may use the cash method of accounting as long as its average annual gross receipts for the prior three years are no more than $32.5 million for 2026 (indexed), unless it is a tax shelter — a threshold most small corporations never approach. And where an individual can deduct only $3,000 of net capital losses a year against ordinary income, a corporation can deduct none against ordinary income but carries its capital losses back three years and forward five against capital gains; a corporation that sells investments or real estate on both sides of the ledger over a few years can come out ahead.

You want the fringe benefits

A C corporation can provide its owner-employees health insurance, group life, and certain other benefits, deduct the full cost, and leave them tax-free to the owner. In an S corporation the same benefits are deductible but get added back to the owner’s W-2. For a family with expensive coverage, that difference adds up.

When it is the wrong answer

Most small businesses, and nearly all one-person service businesses, are better off as a pass-through. The profit is going to be taken out and spent, which means both layers of tax apply. Losses in the early years are stuck inside the corporation instead of reducing the owner’s other income. The 20% QBI deduction is forfeited. And the books have to be kept to a corporate standard, with the salary-versus-dividend line watched, because the IRS looks at a closely held C corporation for salary that is really a disguised dividend.

There is also no easy way back. Converting a C corporation to an S corporation is possible but comes with a five-year tax on built-in gains and other complications, and converting to a partnership or LLC means liquidating the corporation, which is a taxable event. The exit is expensive, so the entrance deserves thought.

Two more rules apply only to C corporations. Charitable contributions are deductible up to 10% of taxable income, and since 2026 only the part above a 1% floor counts, with a five-year carryover for the rest. And a corporation that accumulates earnings beyond its reasonable business needs (above a $250,000 cushion, $150,000 for a personal service corporation) can be hit with a 20% accumulated earnings tax on top of the regular tax; a corporation whose income is mostly investment income and is owned by five or fewer people can owe the 20% personal holding company tax. Both are penalties for using the corporation as a savings account rather than a business.

Colorado

Colorado taxes C corporations at the same flat rate as individuals, currently 4.4%, on the corporation’s Colorado-source income, filed on Form DR 0112. Corporations doing business in several states apportion their income among them. The dividends the owner receives are taxed again on the owner’s Colorado return, so the two layers exist at the state level too.

Setting one up

Forming a corporation is a legal job: articles, bylaws, stock issued properly, and — if Section 1202 is part of the plan — documentation from day one. We refer clients to Tyler Murray of Murray & McCarthy Law in Denver for formation, and we handle the tax side: the Form 1120, the owner’s payroll, and the planning that decides how much comes out as salary and how much stays in.