C Corporation

A C Corporation is the standard corporate form in the United States. It is incorporated under the law of a state, and it is taxed by the federal government as a separate entity. The business itself pays tax on its income. When you take money out as dividends, you pay tax again.

This is called double taxation, and it is the defining feature of a C Corporation. It makes C Corporations more expensive than other choices for some founders, but better for others. The rules change depending on where you are a resident for tax purposes.

What is a C Corporation

Under Internal Revenue Code Section 11, a C Corporation pays federal tax on its taxable income at a single rate of 21 percent. The rate does not change with the size of the company or the number of owners. It was set by the Tax Cuts and Jobs Act in 2017 and has not changed since. Section 11 has its own carve-outs: insurance companies, regulated investment companies and REITs are taxed under other rules (§11(c)), and foreign corporations are taxed under Section 882 (§11(d)). A normal operating company incorporated in a U.S. state pays the 21 percent.

The name "C Corporation" comes from Subchapter C of the Internal Revenue Code, which contains the tax rules for corporations. The IRS distinguishes it from an S Corporation (Subchapter S), which is taxed differently and available only to certain owners.

A C Corporation is incorporated in a state. Delaware is used by many founders because its corporate case law is deep and predictable. Delaware General Corporation Law Section 101(a) says that "any person, partnership, association or corporation, singly or jointly with others, and without regard to such person's or entity's residence, domicile or state of incorporation, may incorporate." There is no residency requirement for the incorporator. A founder living outside the United States can form a Delaware corporation.

The corporation itself is the taxpayer. The federal government sees the corporation as a separate entity from its owners. It files its own return (Form 1120), pays its own tax, and keeps whatever profits remain after the 21 percent is removed.

When the corporation pays money out to its owners as dividends, those owners receive it as individuals and may owe additional tax. This is where the second layer of taxation begins.

🇺🇸 If the IRS counts you as a U.S. person

You own the corporation, and the corporation pays dividends to you. You now face two tax bills.

First, the corporation pays 21 percent federal tax on its taxable income under Section 11. That amount is gone before anything can be distributed.

Second, when the corporation pays you a dividend, you report that dividend as income on your personal tax return (Form 1040). The tax you owe on those dividends depends on your total income and how long you held the stock.

The default rate is your ordinary income tax rate, which runs from 10 percent to 37 percent depending on your total income. A dividend that is "qualified" is taxed instead at long-term capital gains rates: 0, 15 or 20 percent, depending on your income. To be qualified, you must hold the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date (IRC §1(h)(11)(B)(iii), applying the holding-period test in §246(c)). Holding the stock for a year or more clears that test easily.

There is a third federal tax that founders forget. The net investment income tax adds 3.8 percent on dividends once your modified adjusted gross income passes the threshold in IRC §1411. If you are in the 37 percent bracket, your dividend rate is 20 percent plus 3.8 percent, not 20 percent.

You can defer the second layer. If the corporation keeps its earnings and reinvests them rather than paying them out, no dividend tax is due yet. The corporation has already paid 21 percent, and nothing more is owed at the federal level until the money comes out to you. Deferral is not unlimited, though — see the accumulated earnings tax in the FAQ below.

You also have the option to switch structures. A corporation can elect to be taxed as an S Corporation, which pays no tax at the corporate level. The income passes through to the owners and is taxed on their individual returns, so there is no second layer. The election is open to you as a U.S. person, subject to the other conditions in IRC §1361(b)(1): no more than 100 shareholders, only one class of stock, and only individuals and certain trusts and estates as shareholders. See the FAQ below for what the election can cost.

🌏 If it does not

You own a C Corporation, and you are not treated as a U.S. resident for tax purposes.

The corporation still pays 21 percent federal tax on its taxable income. This part is the same for everyone.

But the second layer is different. When a C Corporation pays a dividend to a nonresident alien individual, Internal Revenue Code Section 1441 requires the corporation to withhold tax before sending the money, at a rate of 30 percent. (Section 1442 applies the same 30 percent rule to dividends paid to a foreign corporation.) A tax treaty between the United States and your country of residence can lower that rate. The reduced rate depends on the specific treaty and often on how much of the corporation you own, so the number has to come from the treaty itself. The IRS publishes the rates in its Tax Treaty Tables.

Here is what this means with no treaty. The corporation earns $100. It pays $21 in federal tax, leaving $79. It declares a dividend of $79. The corporation withholds 30 percent of that, which is $23.70, and sends you $55.30. Your country of residence may tax that income again.

The net investment income tax does not reach you. IRC §1411(e) says the 3.8 percent tax does not apply to a nonresident alien.

There is also a filing obligation that U.S.-owned corporations do not have. A domestic corporation that is at least 25 percent foreign-owned must file Form 5472 with its Form 1120 and keep records of its transactions with related parties (IRC §6038A). The penalty for not filing is $25,000 per year, plus a further $25,000 for each 30-day period the failure continues after the IRS gives notice.

The second structural difference is the S Corporation. You cannot elect it. Section 1361(b)(1)(C) says an S Corporation may not "have a nonresident alien as a shareholder." Note that the test is tax residency, not nationality: a non-citizen who is a resident alien for tax purposes can hold S Corporation stock. A nonresident alien cannot.

Where the two lanes split

The double tax in practice

Understanding the total effective tax rate is important if you are deciding between structures.

Suppose a C Corporation earns $100 in taxable income. The corporation owes $21 in federal tax and has $79 left to distribute.

If the owner is a U.S. person in the top bracket and receives a qualified dividend, the dividend rate is 20 percent plus the 3.8 percent net investment income tax, so 23.8 percent. That is $18.80 on $79. The owner keeps $60.20. The combined federal rate is about 39.8 percent, not the 21 percent the corporate rate suggests. This is the number to carry in your head.

If the owner is a nonresident alien and no treaty applies, the corporation withholds the statutory 30 percent of $79, which is $23.70. The owner receives $55.30. The combined federal rate is about 44.7 percent. A treaty that lowers the withholding rate lowers this figure.

Both numbers are federal only. States tax corporate income separately, and the state rate depends on where the corporation is taxable.

This is why owners sometimes leave profits inside the corporation instead of declaring dividends. Taking the money out as a shareholder loan instead is a common suggestion and a risky one: if the loan is not real debt with real terms and real repayment, the IRS can recharacterize it as a dividend, which puts you back where you started. Talk to an accountant before relying on it.

Common mistakes

🇺🇸 If the IRS counts you as a U.S. person

• Thinking the 21 percent corporate tax is the only tax. Many founders picture keeping 79 cents of every dollar and forget that dividends are taxed again.
• Forgetting the 3.8 percent net investment income tax under IRC §1411. The top qualified dividend rate is 23.8 percent, not 20 percent.
• Assuming every dividend gets the capital gains rate. It does not qualify unless the holding-period test in §1(h)(11)(B)(iii) is met.
• Setting up a C Corporation when an S Corporation or a single-member LLC would avoid the double tax. The choice matters, and accountants differ on what is best in a specific situation.

🌏 If it does not

• Underestimating the cash impact of withholding. The corporation can declare the full $79, but it must remit 30 percent of it to the IRS and send you the rest. Plan around what lands in your account, not what was declared.
• Missing Form 5472. A 25 percent foreign-owned corporation files it with Form 1120, and the penalty under IRC §6038A is $25,000 per year.
• Trying to avoid dividend withholding by keeping the money inside the company. Deferral works, but a corporation that accumulates earnings beyond its business needs can be hit with the accumulated earnings tax.
• Forgetting that your home country may tax the dividend too. The U.S. tax is withheld first, and your country taxes what you receive. A treaty may give you a credit.

FAQ

What is the difference between a C Corporation and an S Corporation?

A C Corporation pays tax at the corporate level and again when owners receive dividends. An S Corporation does not pay corporate tax. The income passes through to the owners and they pay tax on their individual returns. But S Corporation ownership is restricted: under IRC §1361(b)(1)(C) a nonresident alien cannot be a shareholder. The test is tax residency, not citizenship — a resident alien can hold S Corporation stock.

Can a nonresident alien own a C Corporation?

Yes. Delaware's incorporation statute, 8 Del. C. §101(a), permits incorporation "without regard to such person's or entity's residence, domicile or state of incorporation." The federal government taxes the corporation on its income at 21 percent, and 30 percent is withheld (or a lower treaty rate) when dividends are paid to you. If you own 25 percent or more, the corporation must also file Form 5472 each year.

Can I avoid the double tax by keeping profits inside the corporation?

You can defer it, not avoid it. A corporation can retain and reinvest earnings, which postpones the shareholder-level tax until money comes out. The limit is the accumulated earnings tax: IRC §531 imposes 20 percent on accumulated taxable income of a corporation "formed or availed of for the purpose of avoiding the income tax with respect to its shareholders." There is a credit that shelters accumulation up to $250,000 ($150,000 for corporations whose main function is services in health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting) under §535(c)(2). One common belief is wrong: §532(c) says the tax applies "without regard to the number of shareholders," so a widely held company is not automatically safe from it.

What is the withholding rate on dividends if I am not a U.S. person?

The statutory federal rate is 30 percent (IRC §1441 for individuals, §1442 for foreign corporations). A tax treaty between the United States and your country of residence can reduce it. The reduced rate is set by that treaty, and it often depends on how large your stake in the corporation is, so look it up in the IRS Tax Treaty Tables rather than assuming a number. The corporation is the withholding agent and is responsible for applying the correct rate.

When should I choose a C Corporation instead of an LLC or S Corporation?

C Corporations are often chosen when a business will raise money from venture capital investors, since most institutional investors expect that structure. They also suit a company that reinvests its profits, because retained earnings are taxed once at 21 percent and no shareholder-level tax is due until money is distributed. The double tax makes them expensive for an owner who wants to take cash out every year.

Can I switch from a C Corporation to an S Corporation?

Yes, if the ownership rules in IRC §1361(b)(1) are met — which rules out a nonresident alien shareholder. The election itself does not generally trigger a tax. Two specific rules can cost you, though:

• LIFO recapture (IRC §1363(d)). If the corporation uses LIFO inventory, the recapture amount goes into its income for its last C Corporation year. This one is triggered by the election.
• Built-in gains tax (IRC §1374). If the corporation sells appreciated assets it held on the date of the election, the gain is taxed at the corporate level at the §11(b) rate. This applies only during the 5-year recognition period that starts with the first S Corporation year, and only when the assets are actually sold — not at the moment of election.

If the business has large embedded gains or LIFO inventory, have an accountant model both before you file.