Unintended Consequences of Taking Corp Dividends vs. Taking a Salary (2024)

FAQs

Is it better to pay yourself a salary or dividends in a corporation? ›

Dividends may yield a marginally lower tax rate than what is usually paid on a salary since they are subject to the corporate tax rate. Dividends are not considered a company expense, and will not lower your company's overall taxable income.

So any income you take as distributions rather than salary saves you that cost in taxes. To curb the obvious temptation to take all your gross receipts as distributions rather than salary, the IRS sets a basic guideline: You have to pay yourself a “reasonable salary.”

If the company is a C Corp, there is no requirement that the corporation pays owner/employee a salary. However, there are IRS guidelines that should be followed.

Using this formula, they divide their business income into two parts, with 60% designated as salary and 40% paid as shareholder distributions. Although many accountants use the 60/40 rule of thumb, it's not officially approved by the IRS.

How dividends are taxed depends on your income, filing status and whether the dividend is qualified or nonqualified. Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status. Nonqualified dividends are taxed as income at rates up to 37%.

S Corporations are unique in that they offer both the limited liability benefits of a corporation and the pass-through taxation of a partnership. In an S Corp, paying yourself generally involves a combination of a salary as an employee and distributions as a shareholder.

The IRS and the courts do not recognize a "rule of thumb" related to the compensation of S Corporation shareholders. It is a myth that a 50/50 split between distributions and wages, or any other rule of thumb, is regularly accepted by the IRS when auditing S Corporations.

You may or may not have heard of the S Corp Salary 60/40 rule. The guideline refers to setting reasonable compensation between 60% and 40% of the business's net profits. This guideline is not set by the IRS. It should not be relied on as the only factor when setting reasonable compensation.

Split income.

Because progressive tax brackets affect C corps and individuals, income splitting can minimize double taxation. By taking a tax-deductible salary and leaving the rest of the profit for reinvestment, you reduce your personal gross income and the business's taxable income.

Paying yourself consistently is essential, as it allows you to stay on top of your personal finances while running your business. Consider your own salary or draw as a regular operating expense — not just something that happens if and when you make a profit.

What does the IRS consider a reasonable salary? ›

The IRS deems “reasonable pay” to be the amount similar businesses pay for the same (or similar) services. This rule is very vague. Therefore, you must do your research and pay yourself a reasonable salary. To do this, you need to consider all the factors the IRS does.

So, once a year, or throughout the year will work as long as it is paid, and it is reasonable wage for work preformed. Below are a couple articles that may be helpful. "The IRS will not object to the SCorp making zero payments to the owner employee when the business is earning little or no income.

The short answer is "no", as long as the S Corp makes no distribution to the owner-employee to avoid payroll taxes. The reality is that the IRS cannot require a business to pay its employees a minimum salary.

Examples of S Corp tax savings

Likewise, the more profit your business earns, the more you'll save. You need to earn at least $40,000 in profit for an S Corp to make sense, though. Otherwise, the costs of forming and running it exceeds the benefits of an S Corp.

Firms pay no dividends due to cash constraints and investment opportunities. Firms do not pay dividends because of poor profitability and earnings. Firms avoid paying dividends due to the cost of raising external funds.

What Percentage Of Your Income Should You Pay Yourself First? As a business owner, determining how much of your income to set aside can be a bit more complex than if you were an employee. However, 10%-15% of your income is generally a good rule of thumb.

The tax advantages of corporations include: The potential to minimize Medicare and Social Security taxes for shareholder-employees. However, you'll also have the additional cost and hassle of managing payroll if you don't have other employees.

If your business is an S-corp, you must pay yourself a salary if you are actively involved in running and managing your business. To keep you from avoiding employment taxes, the IRS requires S-corp owners to pay themselves a “reasonable salary” that is in line with their job duties, education, skills, and experience.