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March 25, 2004
DOUBLE-TAXED CORPORATION INCOME MAY BEAT DEDUCTABLE COMPENSATION |
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Please note:
Articles on taxation matters are, by their very
nature, general in the comments they make. No action
should be taken, based on these articles, without
the benefit of specific advice.
The sharp reduction in the tax rate on dividends has caused us to change our thinking on a number of points. Generally, we advised closely held C corporations to distribute as much of the corporate earnings as possible as a bonus to the shareholder-employee instead of paying a dividend. Retaining income and then paying a dividend results in a double tax - once on the income earned by the corporation and a second time on the dividend income received by the shareholder. The reduction in the tax rate on dividends to 15 percent has caused us to change our thinking.
Example:
A closely held corporation has $50,000 of income remaining after paying salaries, bonuses and all other expenses. If it follows the traditional approach and pays a bonus to the shareholder-employee, the shareholder-employee and the corporation will pay income tax and payroll tax totaling $18,950, computed as follows:
| Income tax (35% bracket) |
$ 17,500 |
| Payroll tax (2.9%) |
1,450 |
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| Total tax |
$ 18,950 |
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On the other hand, if the corporation retains the $50,000 income, pays income tax and distributes a dividend to the shareholder-employee equal to the net amount remaining after income tax, the total tax paid by the corporation and the shareholder-employee is $13,875, computed as follows:
| Corporate income tax (15%) |
$ 7,500 |
Shareholder income tax
(15% x 42,500) |
6,375 |
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| Total tax |
$ 13,875 |
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The tax saved by retaining income and paying a dividend in this example is $5,075 ($18,950 - $13,875). Note that the tax savings will diminish if the shareholder is in a lower tax bracket. Also, this does not apply to personal service corporations, such as medical corporations, because they are taxed at a flat rate of 35 percent.
For more detailed information,
please contact:
Shelly Reitman
Shepard Schwartz & Harris LLP
Chicago, Illinois, U.S.A.
tel: +1(312) 726 8353
e-mail: sreitman@ssh-cpa.com |
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