Thursday, December 10, 2009

S-Corp Dividend Rules

One of the nicest things S-corporations offers is tax-free dividends. Unlike, partnerships, regular corporations, and sole proprietorships, distribution/dividends paid out of profits above wages are not subject to self-employment or FICA taxes.

Example: XYZ is an S-corporation with two shareholders/owners and five additional employees. XYZ has $150,000 in profit before shareholders/owners are paid. Each shareholder/owner is paid a $50,000 wage, plus a $25,000 distribution/dividend. The wage is handled like any other employee wage. The dividend is only subject to ordinary tax, no FICA or self-employment tax; about a 15% savings, or $7,500 per owner.

When I tax plan with S-corp clients I sometimes have a hard time convincing them to pay a dividend rather than all wages. The IRS says S-corps must pay a reasonable wage before dividends are paid. Reasonable is a wide road and requires careful consideration. Once your S-corp pays you a reasonable wage, it is time for dividend distributions of additional funds. The savings can be significant.

Don’t overpay your taxes because you don’t understand the value of the S-corp. Invest time with your friendly accountant and build a plan for the greatest tax savings. The rules are many when it comes to S-corps and the opportunities are equally great. You don’t need to understand basis, debt basis, flow-through income, etc. to take advantage of the benefits. You need a good accountant that lays out what is available to you and how to accomplish the goal.

I encourage you to take this post to your accountant if you have an S-corp. Allow him/her to explain what I outlined above as it relates to you.

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