Can't a closely held corporation just pay out dividends rather than salaries and the recipients avoid SS & medicare taxes and pay a reduced tax rate?
The short answer is "No". The IRS has the ability to insist that officer/shareholders take a "reasonable" salary -- i.e., not too much, not too little. If they take too much, a portion will be "deemed" to be "constructive dividends".
In the case of a C-Corporation, dividends are undesirable, as the money will be taxed twice (once to the corporation, again to the shareholder as dividend income).
In the case of an S-Corporation, dividends (distributions, actually) are not taxed at all, as shareholders are taxed on profits of the corporation. In the past, S-corporation shareholders would take distributions rather than salaries to avoid payroll taxes. Over the past 10 years a substantial body of tax law has evolved which gives the IRS strong enforcement capability in this area. As a CPA I used this tool for years, but always had the shareholders taking SOME salary, but kept it minimal -- it is much more difficult for IRS to argue you didn't take enough salary vs. them saying you took NO salary, which obviously isn't correct.
It is a huge subject, though... |
