The
simplest way to withdraw cash from the corporation is to distribute cash as a
dividend. However, a dividend distribution is not very tax efficient, since it
is taxable to you as the recipient to the extent of your corporation's
“earnings and profits,” but not deductible by the corporation.
There
are, however, several alternative methods available to you that allow you to
withdraw cash from a corporation while avoiding dividend treatment:
(1) To the extent that you have
capitalized the corporation with debt, including any amounts that you have
advanced to the corporation, the corporation may repay the debt without the
repayment being treated as a dividend. Additionally, interest paid on the debt
is deductible by the corporation. This assumes that the debt has been properly
documented with certain terms that characterize debt, rather than equity, and
that the corporation does not have an unduly high debt to equity ratio.
Otherwise, the repayment of the “debt” will also be taxed as a dividend. If,
you choose to make additional cash contributions to the corporation in the
future, you may wish to consider structuring such contributions as debt in
order to facilitate later withdrawals on a tax-advantaged basis.
(2) Reasonable compensation that you, or
members of your family, receive for services actually rendered to the
corporation is taxable to you or your family member, but deductible to the
corporation. The same rule applies to any compensation (i.e., rent) that
you receive from the corporation for the use of property. In either case the
amount of compensation must be reasonable in relation to the services rendered
or the value of the property provided. To the extent the compensation is
excessive, the excess will be nondeductible.
(3) You may withdraw cash from the
corporation without being taxed by borrowing money from the corporation.
However, in order to avoid recharacterization of the
loan as a dividend, it is important that the loan be
properly documented and be made on terms (including provision for interest)
which are comparable to those on which an unrelated third-party would lend
money to you. All payments of interest and principal on the loan should
actually be made in a timely fashion.
(4) You may withdraw cash by receiving
certain fringe benefits that are deductible to the corporation and not taxable
to you. These may include life insurance, certain medical benefits, disability
insurance, dependent care and other benefits. 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 would
allow you (as well as other employees) to take a portion of your compensation
as nontaxable benefits, rather than as taxable compensation.
(5) You may withdraw cash from the
corporation by selling property to the corporation. However, certain types of
sales should be avoided. For instance, you should not sell property to a 50%
owned corporation at a loss, since the loss on the sale will be disallowed. Similarly,
you should not sell depreciable property to a 50% owned corporation at a gain,
since the gain on the sale will be treated as ordinary income, rather than
capital gain. It is therefore preferable to sell either property on which you
will not incur a loss or nondepreciable property to
the corporation. In any event, any sale should be on terms which are comparable
to those on which an unrelated third party would purchase the property. In this
connection, it could be advantageous to obtain an independent appraisal to
establish the value of property which you wish to sell.
If you
would like any additional information please give our firm a call.