Taking Money Out of a Corporation
If you're a shareholder and work for your corporation, you're an employee of the corporation. When deciding how much to pay yourself, be sure it's a reasonable amount. Your salary should be commensurate with what you would pay a stranger to do the same job.
You can also give yourself bonuses throughout the year, for example, quarterly, or just one bonus at year end. Bonuses should be based on something that can be measured. For example, increasing the number units sold by 10%, or reaching some projected dollar amount in sales, or saving a certain amount of money by improving the efficiency of a process, etc.
If the IRS determines that you paid yourself an unreasonably high amount of compensation it can reclassify the excess amount as dividends which are not deductible against corporate income. Dividends are a reduction of stockholders' equity. Moreover, dividend distributions must be included in your gross income when filing your personal income tax return.
- Distributions from a corporation that are made from current or accumulated earnings and profits are reported as dividends.
- Distributions not made from earnings and profits reduce the adjusted basis of the stock in the hands of the shareholder.
- Distributions in excess of adjusted basis of the stock is usually a capital gain for the shareholder.
If you're paying yourself a reasonable salary and want to take more cash out of the business, you can pay yourself a dividend. This may be done quarterly, semiannually, or annually. The corporation must issue Form 1099-DIV to you after year-end.
Bear in mind, dividends paid out of the corporation are not deducted by the corporation as a business expenses. They reduce shareholders' equity.
You can borrow from the corporation. A promissory note should be prepared showing the loan amount, interest rate and a specific repayment date. A formal note is evidence of an arms-length transaction between the corporation and the borrower.
Is the loan really a taxable distribution to you disguised as a loan?
If you borrow from the corporation, the loan could be viewed by the IRS as a taxable dividend distribution to you. Dividends are not deductible by the corporation as an expense but they are taxable income to the recipient. Make sure any loans from the corporation are supported with a promissory note.
If you pay yourself an excessively high salary, the IRS may make a determination to reclassify the excess as a distribution to you.
If no interest is charged or if the interest rate is below the applicable federal rate (it changes periodically), the interest not charged may be treated as a distribution to the shareholder.
Cancellation of debt:
If you borrow from the corporation but don't pay the loan and the corporation cancels the debt, the amount canceled is treated as a distribution to the shareholder.
Renting property to the corporation:
If you rent property to the corporation and the rent is unreasonably more than you would charge a stranger, the excess may be treated as a distribution to the shareholder.
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- Return to the Tax Basics for Startups Table of Contents to find related links.