How Corporations Pay Their Shareholders

Corporations pay their owners in one of two ways: through a salary (if the shareholder is also an employee), and through a profit distribution (also called a dividend in C Corps). Officers are considered to be employees, but shareholders and directors are not (unless they work for the business).

C Corporations have the freedom to choose whether or not to issue dividends. When a C Corporation does choose to distribute profit, its shareholders must declare the amounts received on their personal returns – and pay taxes again. This is the double-taxation trap you hear about with C Corporations. But even so, smart tax planning can make this work in your favor.

S Corporations don’t have the choice on whether or not to distribute profit. The IRS treats the income as distributed in full each year. However, S Corporations don’t pay tax first – so no double tax. An S Corporation is often the ideal structure for a small, beginning business. In the early years, businesses often operate at a loss.

S Corporation taxation flows those losses through to the owners, where they are deducted from each owner’s earned income. You can’t do that with a C Corporation though – losses are suspended within the C Corporation until it had enough net income to take them. This is the main reason S Corporations are so often recommended for early-stage business owners.

This ability to split income is another key tax planning feature. Remember the self-employment tax issue we talked about for sole proprietorships? With a corporation, you can split your income into a combination of salary and profit distribution. Payroll tax is only assessed over the salary portion. This one single factor saves incorporated business owners thousands each year.

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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