What You Should Know About Avoiding Double Taxation
There are many benefits to incorporating. For most people the liability protection alone is well worth it. Traditional C corporations are the premier entity for limited liability, raising capital, and attracting investors. However, with these benefits comes the pitfall of double taxation. This article is specifically written for owners of a C corporation looking to get cash out of their business without incurring double taxation. Luckily, there are many ways to do this and actually save on taxes.
Pay a Bonus or Increase your W-2 salary
Salaries, whether for you or your employees, provide a write off to your business. They are a great way for you to avoid double taxation. Since the money is paid to you as a salary it is written off before the corporation pays its taxes. With the current corporate income tax rate at 21% this is the 1st half of double taxation savings. Next, since the salary is already paid directly to you there is no need to take a dividend distribution from the corporation. This avoids the 2nd half of double taxation which are qualified dividends typically taxed at between 0-23.8%. See the chart below for the tax rate on qualified dividends.
The chart below shows the 2018 qualified dividend tax rates:
|Tax Rate||Single||Married Filing Jointly|
|0%||Up to $38,600||Up to $77,200|
|15%*||$38,601 to $425,800||$77,201 to $479,000|
|20%*||Over $425,800||Over $479,000|
*Does not include additional 3.8% Net Investment Income Tax. Net Investment Income Tax affect singles with incomes over $200,000 and Married Joint filers with income over $250,000.
Of course, the extra income on the W-2 will be reported on your personal 1040 income tax return but this is only one level of taxation and is typically less than incurring double taxation. See below:
The chart below shows the 2018 personal income tax rates:
|Tax Rate||Single||Married Filing Jointly|
|10%||Up to $9,525||Up to $19,050|
|12%||$9,526 to $38,700||$19,051 to $77,400|
|22%||$38,701 to $82,500||$77,401 to $165,000|
|24%||$82,501 to $157,500||$165,001 to $315,000|
|32%||$157,501 to $200,000||$315,001 to $400,000|
|35%||$200,001 to $500,000||$400,001 to $600,000|
|37%||over $500,000||over $600,000|
Avoid Double Taxation by Establishing a 401(k) or SEP-IRA
By setting up these type of retirement plan you are able to reduce your tax bill by saving for your future – not a bad deal! If you are the only employee then setting up a SEP-IRA could be a great option. There are minimal compliance requirements and all contributions to the plan come from the corporation. Because all contributions come from the corporation they don’t need to be paid out as wages to you first. This saves you additional Social Security & Medicare taxes which would occur if you used a 401(k). By law, the corporation can contribute up to 25% of your W-2 wages into the plan.
In contrast, if you do have employees then a SEP-IRA would require you to give each employee a contribution into their accounts equal to the same percentage of their salaries as you chose for yourself. This could get awfully expensive. For this reason, companies with employees may be better off with a 401(k) plan. This is because the plan can be designed so that the corporation does not contribute to the plan. Using this strategy, the owners would pay themselves a higher salary and contribute to the 401(k) as employees. Unlike the SEP-IRA which only has contributions from the corporation, the additional salary would be subject to additional Social Security & Medicare taxes. This isn’t all that bad considering that you will get a larger Social Security benefit when you retire. For this reason, many owners may not mind the added taxes on a 401(k) as opposed to a SEP-IRA.
Lease assets to your corporation to Save on taxes
Why own property or equipment in a corporation when you can own them in your own name and lease them to your business? Doing so allows your business to write off the expense of the lease and reduce the corporation’s taxable income. Of course, you will report the lease income on your personal tax return but you can offset this with depreciation, repairs, and maintenance costs. Best of all, since the asset isn’t owned by the corporation you are free to do whatever you want with it. If you haven’t noticed it already, leasing assets to your corporation is a great way to draw money from your corporation without paying payroll taxes.
Take Advantage of Health Insurance Benefits & Avoid Double Taxation
The Traditional C Corporation is the ultimate business structure for tax free fringe benefits. No other entity comes close. One of the most popular types of tax free fringe benefits is employer provided health insurance. The point here is that fringe benefits for shareholder/employees of C-Corporations are fully deductible by the corporation, while most fringe benefits paid for owner/employees of S-Corporations and partnerships are, for all practical purposes, nondeductible. Thus, deducting shareholder/employee fringe benefits is a significant advantage of the C-Corporation. This provides a great way of pulling money out of your corporation to purchase health insurance.
Of course, this list is not all encompassing. There are numerous other ways to legally save on corporate income taxes. Strategies like these are a core service that our firm offers. To implement these strategies or discuss other ways to avoid double taxation just fill out the contact us form and we would be happy to assist you. For more information on tax planning please visit our tax planning page.