The Tax Implications of C Corporations

A C corporation is a legal entity that exists separately from its owners and is taxed as a separate entity. As a result, C corporations are subject to double taxation: the corporation pays income tax on its profits, but the shareholders must also report their dividends on their personal income-tax returns.

Double taxation is a major disadvantage of a C corporation, and it can take a major bite out of the corporation's profits and its shareholders' dividends. But you can minimize your tax exposure if you keep a few rules in mind:

Distributing corporate profits. In small privately held corporations, shareholders may also serve as the corporation's directors and employees. Employees are entitled to salaries, and the corporation can elect to pay enough in salary and bonuses so no taxable profits remain at the end of the fiscal year. As a result, shareholders will only pay individual income taxes.

Income splitting. The government taxes the first $75,000 of corporate profits at a lower rate than the individual owners' tax rates. Therefore, you may want to split your C corporation's income between yourself and the corporation. This allows you to pay taxes on the salary you pay yourself at your individual income rate, while the profits retained in the corporation are taxed at the lower corporate tax rate.