Taking cash out of your corporation without incurring a heavy tax burden, especially avoiding the higher taxes associated with dividend treatment, requires strategic planning and a deep understanding of tax laws. By employing tax-wise strategies, business owners can maximize their income and minimize their tax liabilities. This article explores several methods for extracting cash from a corporation while avoiding or minimizing dividend treatment.

 

Salary and Bonuses

Paying yourself a reasonable salary or bonus is one of the most straightforward methods to take money out of your corporation. The IRS requires the salary to be "reasonable," meaning it must be comparable to what businesses similar to yours would pay for similar services. While salaries and bonuses are tax-deductible for the corporation, they are subject to personal income tax and payroll taxes.

 

Loan to Shareholders

Another method is to structure withdrawals as a loan from the corporation to its shareholders. For this strategy to avoid being reclassified as a disguised dividend by the IRS, the loan must be made under terms that reflect a bona fide debtor-creditor relationship, including a formal loan agreement, a fixed repayment schedule, and a reasonable interest rate. It's crucial to ensure that these loans are treated as genuine and are repaid according to the agreement to avoid tax complications.

 

Rent and Lease Agreements

If the shareholder owns property, they can lease this property to the corporation. This method allows the shareholder to withdraw cash from the corporation as rental income, which is generally deductible by the corporation as a business expense. The rental agreement must be based on fair market values to be respected by tax authorities and avoid reclassification as a disguised dividend.

 

S Corporation Election

Electing S corporation status can be a tax-efficient strategy for withdrawing cash from a corporation. S corporations are pass-through entities, meaning the income, losses, deductions, and credits flow through to shareholders, who report these on their personal tax returns. This setup allows shareholders to receive distributions from the corporation's earnings without the double taxation typical of C corporations, provided the distributions do not exceed the shareholder's stock basis.

 

Employee Benefits and Reimbursements

Implementing a comprehensive employee benefits plan, including health insurance, retirement plans, and educational assistance, can be an effective way to extract value from your corporation tax-efficiently. These benefits are generally deductible by the corporation and tax-free to the receiving employee-shareholder. Similarly, setting up an accountable plan for expense reimbursements is a tax-wise way to receive tax-free cash reimbursements for business expenses paid personally by the shareholder.

 

Capital Gains

Selling assets or shares of the corporation to the shareholder or a related party at fair market value can result in capital gains treatment, which is often taxed at a lower rate than dividend income. This approach requires careful planning to ensure compliance with tax laws and to avoid unintended consequences.

 

Extracting cash from your corporation while minimizing the tax impact requires careful planning and a thorough understanding of the tax implications of each strategy. It's essential to consult with a tax professional or financial advisor to determine the most effective and compliant strategies for your specific situation. By leveraging the methods outlined above, business owners can ensure they are making the most tax-efficient decisions when taking cash out of their corporations.