- Find out how capital repayments can work to your tax advantage.
- Discover how the corporation may repay a debt to you.
- Learn the proper way to borrow tax-free money from the corporation.
- Learn more about getting the equivalent of a cash withdrawal in fringe benefits.
- Find out which property sales to the corporation you should avoid.
Do you own a closely held corporation? Then you may have an interest in easily withdrawing money from your business at the lowest possible tax cost. The simplest way is to distribute cash as a dividend. However, a dividend distribution isn’t tax-efficient, since it’s taxable to you to the extent of your corporation’s “earnings and profits.” And it’s not deductible by the corporation. Here are some strategies Fiducial suggests.
Fortunately, several alternative methods exist that may allow you to withdraw cash from a corporation while avoiding dividend treatment. Below are five strategies to consider.
To the extent that you’ve capitalized the corporation with debt, including amounts that you’ve advanced to the business, the corporation can repay the debt without the repayment being treated as a dividend. Additionally, you may deduct interest paid on the debt by the corporation. This assumes that the debt has been properly documented with terms that characterize debt and that the corporation doesn’t have an excessively high debt-to-equity ratio. If not, the “debt” repayment may be taxed as a dividend. If you make future cash contributions to the corporation, consider structuring them as debt. This will facilitate later withdrawals on a tax-advantaged basis.
The business may deduct reasonable compensation that you, or family members, receive for services rendered to the corporation. However, it’s also taxable to the recipient(s). This same rule also applies to any compensation (in the form of rent) that you receive from the corporation for the use of property. In both cases, the compensation amount must be reasonable in terms of the services rendered or the value of the property provided. If it’s considered excessive, the excess will be a nondeductible corporate distribution.
You can withdraw cash tax free from the corporation by borrowing money from it. However, to prevent a characterization of the loan as a corporate distribution, you should properly document it in a loan agreement or note. It should also be made on terms that are comparable to those in which an unrelated third party would lend money to you. This includes a provision for interest and principal. Also, consider what the corporation’s receipt of interest income will mean.
You may want to obtain the equivalent of a cash withdrawal in fringe benefits, which aren’t taxable to you and are deductible by the corporation. Examples include life insurance, certain medical benefits, disability insurance and dependent care. We consider most of these benefits tax-free only if provided on a nondiscriminatory basis to other corporation employees. You can also establish a salary reduction plan. This would allow you (and other employees) to take a portion of your compensation as nontaxable benefits, rather than as taxable compensation.
You can withdraw cash from the corporation by selling property to it. However, you should avoid certain sales. For example, you shouldn’t sell property to a more than 50%-owned corporation at a loss, since the loss will be disallowed. And you shouldn’t sell depreciable property to a more than 50%-owned corporation at a gain, since the gain will be treated as ordinary income, rather than capital gain. A sale should be on terms that are comparable to those of an unrelated third party purchasing the property. You may need to obtain an independent appraisal to establish the property’s value.
Interested in discussing any of these ideas? Want to make the most out of your corporation at the lowest tax cost? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations.
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