- Learn how to withdraw funds from a closely held corporation with minimum tax cost.
- Could capital repayments help you avoid costly tax consequences?
- Learn how corporations can deduct salaries.
- Find out how to borrow from a corporation tax-free.
- Learn how to utilize fringe benefits as a deduction.
- You have the option of selling property to a corporation, but which property sales should you avoid?
Do you want to withdraw cash from your closely held corporation at a minimum tax cost? The simplest way is to distribute cash as a dividend. However, a dividend distribution isn’t tax-efficient. It’s taxable to you to the extent of your corporation’s “earnings and profits.” It’s also not deductible by the corporation. Fiducial has more ideas for withdrawing cash from corporations while avoiding negative tax consequences below!
Five alternatives for withdrawing cash from corporations with minimum tax costs
Fortunately, there are several alternative methods that may allow you to withdraw cash from a corporation while avoiding dividend treatment. Here are five areas where you may want to take action:
To the extent that you’ve capitalized on the corporation, including amounts you’ve advanced to the business, the corporation can repay the contribution without the repayment being treated as a dividend.
Repayments of capital may occur once a corporation makes a distribution in excess of accumulated and current earnings and profits. However, the IRS is very prone to recast those distributions as compensation if compensation is low. Consider this if you decide to go this route.
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. The same rule applies to any compensation in the form of rent that you receive from the corporation for the use of property. In both cases, the amount of compensation must be reasonable in relation to the services rendered or the value of the property provided. If excessive, the excess will be nondeductible and treated as a corporate distribution.
You may withdraw cash from the corporation tax-free by borrowing from it. However, to avoid having the loan characterized as a corporate distribution, you should properly document it in a loan agreement or a note and create terms comparable to those on which an unrelated third party would lend money to you. This should include a provision for the payment of interest and repayment of principal. You should make all interest and principal payments when required under the loan terms. Additionally, to avoid having the loan recharacterized by the IRS as compensation, reasonable compensation should also be paid.
Finally, consider the effect of the corporation’s receipt of interest income.
Consider obtaining the equivalent of a cash withdrawal in fringe benefits that are deductible by the corporation and not taxable to you. Examples are life insurance, certain medical benefits, disability insurance, and dependent care. Most of these benefits are tax-free only if provided on a nondiscriminatory basis to other employees of the corporation. You can also establish a salary reduction plan that allows you (and other employees) to take a portion of your compensation as nontaxable pre-tax retirement contributions, rather than as taxable compensation.
Another way to withdraw cash from the corporation is to sell 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. The gain will be treated as ordinary income, rather than capital gain.
A sale should be on terms that are comparable to those on which an unrelated third party would purchase the property. You may need to obtain an independent appraisal to establish the property’s value.
Keep taxes low
Interested in discussing some of these approaches? We’ll help you get the most out of your corporation at the minimum tax cost. Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.