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6 Reasons to Separate Real Estate from Your Business Assets
When businesses acquire real estate, they often title it under the company name. Although this might seem...
Submitted By: Eric E. Ehrenberg on Mar 12, 2024 2:00:00 PM
C corporation owners often need to take cash out of the business to pay personal expenses or to shield excess cash from creditors. Paying dividends is one way to withdraw cash from the business, but it generally has some significant downsides. Fortunately, additional options may be available. Here's what you need to know.
Problems with Dividends
The biggest drawback with dividends is that they're taxable to the recipient and not deductible by the corporation. This leads to double taxation: 1) The corporation pays tax on its earnings, and 2) the shareholder pays taxes on the dividends.
The shareholder generally will pay capital gains tax, which ranges from 15% to 20%, depending on the shareholder's taxable income and filing status. Dividends also might be subject to the net investment income tax (NIIT). The 3.8% NIIT applies when modified adjust gross income exceeds the following thresholds:
In addition, the amount of dividends that can be paid is subject to certain limitations. For example, state statutes intended to prevent fraudulent distributions to owners may apply. And, if a dividend exceeds the corporation's current-year or accumulated earnings and profits, the excess is considered a return of capital. While capital returns aren't taxable, they reduce the basis in your shares, which will result in extra capital gains when the business (or business interest) is sold.
Another concern is that you could draw scrutiny if you haven't paid dividends in the past. If the corporation is struggling to pay its debts on a timely basis, the payment of dividends could suggest fraud.
Tax-Savvy Alternatives
Consider the following five alternative means of withdrawing cash from your corporation to potentially avoid double taxation:
With a salary reduction plan, the corporation makes pretax contributions to certain retirement plans that are immediately deductible for the business, while deferring your tax liability. Additional rules and restrictions may apply. For example, if an employer provides life insurance to employees, up to $50,000 is tax free. But if the policy provides a death benefit of more than $50,000, the imputed cost of the coverage in excess of $50,000 must be included in an employee's income.
Important: In general, shareholders should be cautious about contributing additional capital to the business. In most cases, you'd be better off obtaining financing in the corporation's name.
Formalities Matter
Getting cash out of your corporation can be a complex undertaking with many potential pitfalls to navigate around. This article only provides a brief overview of the issues and the requirements involved. Whichever route you select to withdraw cash from your corporation, it's important to document the details and adhere to the relevant corporate formalities. For instance, you should include the decision in shareholder meeting minutes, as well as adopt formal written and consistent plans or policies. Your SSB tax advisor can help you make the best choice for your circumstances and satisfy the applicable substantiation requirements.
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