C Corporations and Distribution

As a C Corporation shareholder, you have two big questions. How will you reduce profit (if you have an accumulated retained earning issue)? How will you get cash out of the company?

Generally, speaking the profit is reduced by benefits and salary that you take from the company. As personal income tax rates rise and if a C Corporation tax rate reduction occurs, it may become less of an issue. At that point, you’ll want to keep profit in the corporation because it will pay at a lesser rate. And, as long as you can prove that there is a business purpose for retaining the profits, you won’t get an excess tax penalty.

It’s another question, though, on how to get cash out of the C Corporation. Make sure you have the answer to it before you start storing cash.

There are five popular ways to get cash out of your C Corporation:

Tax-free Benefits. These are the type of benefits that we discuss in Tricks and Traps of C Corporations and include medical insurance, MERP (medical expense reimbursement plans), long term disability plans, physical fitness plans, education plans and the like. The advantage for these is that as long as you’re following the rules the C Corporation gets a deduction and you don’t have to pay tax on the benefit.

Salary. This effectively moves income from the C Corporation to you. It’s a deduction for the corporation and income to you. The IRS will be watching to see that you’re taking a reasonable salary for what you’re doing. And remember you need to take a salary to take advantage of employee benefits.

Dividends. The C Corporation may also pay shareholders a dividend. The dividend will be taxable to you at the current dividend tax rate but is not a deduction for the corporation. This is double taxation.

Loans. You could take a loan from the corporation. The challenge is that the IRS will be watching to make sure that the loans aren’t really “constructive dividends”, which mean that they could count for double taxation. A better solution is 5 below.

Invest. In this case, we don’t want appreciating assets inside a C Corporation or even have the C Corporation own units in an LLC (limited liability company) that holds an appreciating asset. We prefer to have the C Corporation loan money to an LLC, with a fair interest rate, so that the LLC then holds the assets.

Other. It’s also possible to use some life insurance products or pension plans to move money out of a C Corporation. See your tax advisor for more on how these strategies could work for you.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

Got questions? Contact us! We’re here for you.

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