Tax and Business Alert – April 2024
438
words
Abstract: Owners of incorporated businesses know
there’s a tax advantage to taking money out of a C corporation as compensation
rather than as dividends. The reason: A corporation can deduct the salaries and
bonuses that it pays executives, but not dividend payments. Therefore, if funds
are paid as dividends, they’re taxed twice, once to the corporation and once to
the recipient. Money paid out as compensation is taxed only once — to the
employee who receives it.
If
you own a C corporation, you know there’s a tax advantage to taking money out
as compensation rather than as dividends. The reason: A corporation can deduct
the salaries and bonuses that it pays executives, but it can’t deduct dividend
payments. Therefore, if funds are paid as dividends, they’re taxed twice, once
to the corporation and once to the recipient. Money paid out as compensation is
taxed once — to the recipient employee.
However,
the amount of money you can take out of the corporation this way is limited.
Under tax law, only compensation deemed to be reasonable can be deducted. Any
unreasonable portion isn’t deductible, and may be taxed as if it were a
dividend paid to a shareholder. Keep in mind that the IRS is generally very
interested in unreasonable compensation payments made to someone “related” to a
corporation, such as a shareholder-employee or a member of a shareholder’s
family.
Steps to
help protect yourself
There’s
no simple way to determine what’s reasonable. If the IRS audits your tax return,
it will examine the amount that companies in similar industries would pay for
comparable services under comparable circumstances. Factors considered include
the employee’s duties and the amount of time spent on those duties, as well as
the employee’s skills, expertise and compensation
history. Other factors that may be reviewed are the complexities of the
business and its gross and net income.
There
are steps you can take to make it more likely that the compensation you earn
will be considered “reasonable,” and therefore deductible by your corporation.
For example, you can:
1.
Keep compensation in line with what
similar businesses are paying their executives (and keep whatever evidence you find
about what others are paying).
The
challenges are many, but you can avoid some problems by planning ahead. Contact
us if you have questions or concerns about your situation.
©
2024