Want to withdraw cash from your closely held C corporation with minimal tax cost?

The simplest way to distribute cash is as a dividend. However, dividends are taxable to you and not deductible by the corporation.

Here are several alternatives that allow you to withdraw cash from a corporation while avoiding the dividend treatment.

Receive a Debt Payment

If you’ve capitalized the corporation with debt, which includes any amount that you’ve given to it, the corporation may repay the debt to you without being considered a dividend. Interest paid on the debt is income to you, but deductible by the corporation.

You must properly document the debt and the corporation must not have a high debt-to-equity ratio. Otherwise, the repayment of the “debt” may be taxed as a dividend. If you make cash contributions to the corporation in the future, consider structuring the contributions as debt for later withdrawals at a tax-advantage.

Borrow From the Corporation

You may withdraw cash from the corporation tax-free by borrowing money from it. However, you must document it properly in a loan agreement and make the terms of the agreement comparable to those from an unrelated third-party. You should make all principal and interest payments when required. Also, consider the tax consequences of the corporation’s receipt of interest income.

Reasonable Compensation

Compensation that you receive for services rendered are taxable to you but deductible by the corporation. This also applies to anything you receive from the corporation for the use of property. In either case the compensation must be reasonable in relation to the services rendered. If excessive, the excess will be nondeductible, and will be treated as a corporate distribution.

Receive Fringe Benefits

You may receive fringe benefits (the equivalent of a cash withdrawal) that are deductible by the corporation and not taxable to you. These 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 the other employees of the corporation. You may also take a portion of your salary as nontaxable benefits, rather than as taxable compensation.

Sell Property to the Corporation

You may withdraw cash from the corporation by selling property to it. However, certain types of sales should be avoided:

• Don’t sell property to a more than 50% owned corporation at a loss, since the loss on the sale will be disallowed.
• Don’t sell depreciable property to a more than 50% owned corporation at a gain, since the gain on the sale will be treated as ordinary income, rather than capital gain.

Any sale should be on terms that are comparable to those from an unrelated third party.

Be Prudent

To avoid unwanted tax consequences when being compensated, it’s wise to seek professional guidance. PDM’s tax experts can help advise you on the best course of action. Contact us; with our years of technical experience, advanced training, and cutting edge technology, we are your financial partner.