2018 Tax Law - Benefits to being a C-Corp

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The Benefits of Being a C-Corp

Authored by Bryan Springmeyer
Bryan Springmeyer is a California corporate attorney who represents startup companies.
The information on this page should not be construed as legal advice.

When deciding what type of business to form or operate as, founders and management of a company will often consider taxation as a primary factor. Other factors, such as liability, minority equity holder rights, and management obligations, are relatively similar across entities – or at least have difficult to quantify differences. The tax difference is an easy one to see and measure [in fact, you can use this calculator to compare taxation between entity types across different scenarios].

Historically, a C-Corp has been very unappealing for profitable companies because of a concept referred to as “double taxation”. This term applies to the tax that a corporation pays on its income (profits), and then again on those profits as they’re distributed to shareholders as dividends. The aggregate of these two taxes was much higher than the taxes the individual owners would have paid with a pass-through entity such as an LLC or S-Corp. However, the 2018 tax law changes have shrunken the disparity between C-Corp and pass-through taxation. As such, it makes sense to consider what other benefits exist for C-Corps.

One of the primary reasons for my clientele, tech startups, to form as C-Corps is because venture capital investors will require this. This will be true in other spaces, as well, where investors are private equity funds (traditional PE or hedge funds) and the institutional investors that make up the fund, such as school endowments and pensions, are nonprofits that cannot invest indirectly into a pass-through entity without potentially recognizing unrelated business income tax. Additionally, investors in many spaces do not want to be a part of the annual accounting of the company, as would be the case in a pass through entity, and instead are simply looking for the opportunity to buy stock and liquidate it at an appreciated price.

There are some specific tax benefits that apply to qualified small business stock (QSBS), which among other things, must be stock in a domestic C-Corp. Pursuant to IRC 1202, QSBS held for over five years is subject to a tax free sale up to $10 million or 10 times the investment made to purchase that stock, whichever is greater. This means founders may get a tax free sale on up to $10 million in an acquisition or IPO, and investors may get $10 million or more (if they invested over $1 million into the stock being disposed of). IRC 1045 provides a mechanism to roll over gain of disposed stock into a new similar investment (similar to a 1031 exchange).

Another benefit applying to C-Corp stock is IRC 1244, which allows an ordinary loss deduction for up to $50,000 (or $100,000 for married couples filing jointly) on losses from the disposition of qualifying stock.

With these benefits, a company whose model is to grow and exit without being concerned about profitability in that growth stage already found more appeal in being a C-Corp. Now that new tax laws are shrinking the disparity of “double taxation,” the appeal of keeping these benefits available even if the company may be profitable is more likely. Depending on the length and extent of profitability, these other C-Corp tax benefits may outweigh any operational tax differences.