Chapter
11
Entity Choice: The C
Corporate Taxpayer
Characteristics of a Corporation
Limited liability of shareholders
– Note, however, that owners of closely-held corporations often
are required to sign personal liability on bank debt.
– Most important protection is against “unforeseen” liabilities.
– Risk is further reduced by dividing corporate assets among
multiple entities (e.g., subsidiaries).
Unlimited life (e.g., corporation does not end upon death of
founding shareholders)
Centralized management
Free transferability
– Closely-held corporations can restrict sale outside exiting
shareholder group.
– Even without restrictions on sale, it is often difficult to find
buyers for stock in closely held corporation.
Distributions to Investors – Tax Consequences
Interest payments:
Deductible by corporation;
Taxable to recipient at ordinary tax rate.
Salary/wages to shareholders:
Deductible by corporation;
Taxable to recipient as ordinary income;
Subject to employment taxes as well as income tax.
Distribution of profits to shareholders:
Not deductible by corporation;
Taxable to shareholders at preferential rates (0-23.8%).
Entity Choice: Conduit entities do not have this double
tax issue.
Distributions to Investors – Issue of Double Tax
Nondeductibility of dividends makes paying
dividends hard to explain = expected by
investors even though double tax.
One result is the high leverage of many
corporations, because interest expense is
deductible.
Investors may prefer that the corporation keep
the funds and reinvest them; sell stock for a
capital gain in future = growth stock.
Double tax issue is less significant with
relatively low dividend tax rate.