Learning how to start a C Corporation (C-corp) is a bit complex. We’ll walk you through the process—from forming a corporation per your state’s laws and transferring cash and other assets to setting up payroll and making quarterly estimated tax payments.
Most large businesses are C-corps as they can have thousands of shareholders. For example, most publicly traded companies are C-corps. However, they can also have as few as one shareholder and are common among small businesses. Learn more about C-corp taxation.
Step 1: Form a Corporation According to Your State’s Laws
When forming a corporation, you must follow the rules and regulations of the state in which you plan to incorporate carefully. Each has its own guidelines, so it’s essential to find out what they are before you start.
Generally, the first step in creating a C-corp is filing the articles of incorporation with the state office in charge of registering businesses where you are located. Articles of incorporation generally include information about the corporation’s name, purpose, registered agent, and the number and types of shares of stock that the corporation is allowed to issue.
In addition, you may need to get different licenses and permits to run your business based on the industry and location. You should also write company bylaws, which are the rules and procedures for running the business.
Visit our guide to the best online legal services if you need guidance with this process.
Step 2: Apply for an EIN
As you prepare to set up your C-corp, you’ll need an employer identification number (EIN). This is because a C-corp is recognized as a separate tax-paying organization for federal income tax reasons.
You can obtain an EIN for free by applying online, by mail, or by fax. The quickest and most efficient way to get one is to apply for an EIN via IRS’s website. A valid taxpayer identification number (TIN), such as a Social Security number or an individual TIN (ITIN), and a valid email address are required to apply online.
Our guide on how to get an EIN will walk you through the process. It also covers who needs one and what to do if you misplace yours.
Step 3: Transfer Cash & Other Assets as Part of a Section 351 Exchange
You’ll also need to transfer cash and other assets to your corporation—this is called a Section 351 exchange. This type of exchange is a tax-deferred transaction that allows you to give some money and other assets to your newly formed corporation in return for stock in the corporation. Once you complete these transactions, you’ll need to keep track of the information related to the transfer to file your taxes during the tax season.
Don’t transfer real estate to your C-corp.
When you do a 351 exchange, it’s not in your best interest to transfer any real estate into the corporation. When real estate is given to a C-corp in a 351 exchange, it generally causes tax problems.
While the transfer of property into the C-corp tax is free, any unrealized gain on the property is also transferred into the C-corp. When the C-corp eventually sells or distributes the property, the unrealized gain will be recognized and taxed at the corporate rate. Instead of transferring ownership in the real estate, it is better to lease it to the newly formed corporation.
Mr. X owns a nonresidential building with an FMV of $400,000 and a basis of $100,000. In January 2021, Mr. X created a C-corp and contributed the building to the corporation using an IRC Section 351 transfer, in exchange for a 100% ownership interest in the corporate stock.
After the transfer, his basis in the corporate stock was $100,000, and the corporation’s basis in the building was $100,000. By December 2022, he had run into financial difficulties and decided to liquidate the corporation. The appreciated value of the building was $420,000.
The corporation must recognize a gain of $320,000 on the liquidation of the building. This is true even though $300,000 of the gain occurred prior to the corporation’s existence. To make matters much worse, Mr. X must also recognize a $320,000 gain on the receipt of the building in a liquidating distribution since his basis in the liquidated stock was only $100,000.
If Mr. X had simply leased the building to his new corporation, then there would never have been a change in ownership, and no gain or loss would be recognized (related to the building) on the corporate liquidation.
Step 4: Set Up Payroll for Services Performed
Once your C-corp starts generating revenue, you can receive compensation in the form of dividends or a salary. To receive the latter, you’ll need to set up a payroll system to pay yourself, your employees, and any officers you may have reasonable compensation.
Reasonable compensation refers to the amount of compensation that is considered reasonable and appropriate based on job duties, experience, and industry standards. If you need help determining what compensation is considered reasonable in your industry, you can use the United States Bureau of Labor Statistics’ list of Occupational Employment and Wage Statistics.
After determining what is considered reasonable compensation in your industry, you will need to locate a reliable payroll system. The best payroll software for small businesses calculates employee wages and deductions with precision and automatically pays and files payroll taxes.
Step 5: Choose Accounting Method & Fiscal Year By Filing First Tax Return
When the time comes to file your corporate tax return, you will need to indicate your method of accounting and fiscal year on the return. You’ll provide this information on IRS Form 1120, U.S. Corporation Income Tax Return. You’ll need to know this not only for your federal return—you’ll also need to have this information handy for your state tax return. A C-corp must pay state taxes and file a state income tax return in addition to making a federal income tax return.
To learn how to complete the form, read our step-by-step guide on how to fill out Form 1120.
Accounting Method
There are two main methods of accounting: cash basis and accrual basis. The method you choose will determine how you report income and expenses.
- The cash basis method recognizes income and expenses when they are received or paid. It’s generally advantageous for taxes to go with this method, which most small businesses are allowed to use.
- The accrual basis method recognizes income and expenses when they are earned or incurred.
Read our cash-basis vs accrual-basis accounting methods comparison, which also indicates when to use each, to learn more.
Fiscal Year
Choosing a fiscal year will allow you to accurately measure the corporation’s revenue and accurately report the corporation’s income on its tax return. The fiscal year is the 12-month period for which you choose to report your income and expenses.
Most businesses use the calendar year (January 1 to December 31) as their fiscal year. However, you can choose any 12-month period that ends on the last day of any month except December—unless you’re a personal service corporation (PSC).
Step 6: Make Quarterly Estimated Tax Payments
C-corps may be subject to either the personal holding company (PHC) tax or the accumulated earnings tax, but both of these can be avoided by paying adequate dividends. Learn more about personal holding companies and the accumulated earnings tax before the end of your first year.
If you’re expecting to owe at least $500 in taxes, you might need to make estimated tax payments.
Step 6.1: Calculate your estimated tax payments: To calculate your estimated tax payments, you will need to use IRS Form 1120-W, Estimated Taxes for Corporations. You can visit the IRS’s website to learn more about Form 1120-W.
If this is your first year doing business, you won’t have to worry about this step, but in any subsequent year, you just may. If you anticipate that you will owe at least $500 in the second year and you plan to make an installment payment, the amount of each installment must be 25% of either
- 100% of the tax shown on the return for the taxable year (or, if no return is filed, 100% of the tax for such year); or
- 100% of the tax shown on the return for the preceding taxable year.
Step 6.2: Make your estimated tax payments: You will need to make estimated tax payments four times a year, by April 15, June 15, September 15, and January 15 of the following year (or the next business day if the due date falls on a weekend or holiday). Corporations must deposit the payment using the IRS’s Electronic Federal Tax Payment System.
Step 6.3: Keep track of your payments: You can use Form 1120-W to keep track of your payments.
Adjust your estimated tax payments if necessary. If your income or expenses change during the year, you may need to adjust your estimated tax payments to avoid underpayment penalties. You can use Form 1120-W to recalculate your estimated tax payments.
C Corporation Advantages & Disadvantages Compared to Schedule C Businesses
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Frequently Asked Questions (FAQs)
Yes, you can switch from a C-corp to an LLC, but it requires several complicated and expensive steps. First, a new LLC must be formed, then the corporation’s assets and liabilities must be transferred to the new LLC which might be taxable and, finally, the corporation must be dissolved.
If your corporation hires and pays contract workers who were paid at least $600 for services, you must issue IRS Form 1099-NEC to the contractor.
Yes, in addition to filing a federal income tax return, a C-corp must also pay state taxes and file a state income tax return.
Bottom Line
A C-corp is a type of business structure wherein the assets of the owners are kept separate from the assets of the company. C-corps limit investors’ and owners’ liability and pay taxes separately from their investors and owners. This type of legal structure has many benefits and drawbacks but may be perfect for your growing business.
