Strategies for Tax-Efficient Cash Withdrawals from Your Corporation

Extracting cash from your closely held corporation in a tax-efficient manner can be challenging. The most straightforward method is to distribute cash as a dividend. However, this approach is not tax-efficient as it is taxable to you to the extent of your corporation’s “earnings and profits” and is not deductible by the corporation.

Alternative Approaches

Fortunately, there are alternative strategies that may allow you to extract cash from a corporation while avoiding dividend treatment. Here are five potential options:

1. Compensation: Compensation that you or family members receive for services rendered to the corporation is deductible by the corporation. However, it is also taxable to the recipient(s). This rule also applies to any compensation (in the form of rent) that you receive from the corporation for the use of property. The compensation must be reasonable in relation to the services rendered or the value of the property provided. If it’s excessive, the excess will be nondeductible and treated as a corporate distribution.

2. Fringe Benefits: You may consider receiving fringe benefits that are deductible by the corporation and not taxable to you. Examples include life insurance, certain medical benefits, disability insurance, and dependent care. Most of these benefits are tax-free only if provided on a nondiscriminatory basis to other corporation employees. You can also establish a salary reduction plan that allows you (and other employees) to take a portion of your compensation as nontaxable benefits, rather than as taxable compensation.

3. Capital Repayments: If you’ve capitalized the corporation with debt, including amounts that you’ve advanced to the business, the corporation can repay the debt without the repayment being treated as a dividend. Additionally, interest paid on the debt can be deducted by the corporation. This strategy assumes that the debt has been properly documented with terms that characterize it as debt and that the corporation doesn’t have an excessively high debt-to-equity ratio. If these conditions are not met, the “debt” repayment may be taxed as a dividend. If you make cash contributions to the corporation in the future, consider structuring them as debt to facilitate later withdrawals on a tax-advantaged basis.
    

4. Loans: You can withdraw cash from the corporation tax-free by borrowing money from it. However, to avoid having the loan characterized as a corporate distribution, it should be properly documented in a loan agreement or a note and be made on terms that are comparable to those on which an unrelated third party would lend money to you. This should include a provision for interest and principal. All interest and principal payments should be made when required under the loan terms. Also, consider the effect of the corporation’s receipt of interest income.

5. Property Sales: You can withdraw cash from the corporation by selling property to it. However, certain sales should be avoided. For instance, you shouldn’t sell property to a more than 50% owned corporation at a loss, as the loss will be disallowed. And you shouldn’t sell depreciable property to a more than 50% owned corporation at a gain, as the gain will be treated as ordinary income, rather than capital gain. A sale should be on terms that are comparable to those on which an unrelated third party would purchase the property. You may need to obtain an independent appraisal to establish the property’s value.

Minimizing Taxes

If you’re interested in discussing any of these strategies, please contact us. We can assist you in maximizing the benefits from your corporation while minimizing the tax cost.