How to Withdraw Money From a C CorporationBy Tom Speranza, J.D.
How to Withdraw Money From a C CorporationBy Tom Speranza, J.D.
If your business operates as a C corporation, the company pays taxes on its income, where the entity itself is a taxpayer. If the company had formed as a pass-through entity (a limited liability company, S corporation, or partnership), it would allocate its income to the owners, who would then pay taxes with their individual tax returns.
For that reason, the U.S. Internal Revenue Service (IRS) pays close attention to a C corporation's payments to its shareholders (and the expenses it pays on behalf of the shareholders), particularly when the company is closely held and the shareholders are also employees. The IRS requires corporations to account for their expenses and other disbursements accurately and report all corporate income.
If the corporation has shareholders who don't work in the business—called outside shareholders—the company's officers and directors also have obligations under state law to limit company expenses and disbursements to those that are legitimately necessary and related to the corporation's business.
C corporations legally distribute money to their shareholders in five ways.
For shareholders who work in the business, a salary is the easiest way to disburse funds to an owner. Being a W-2 employee also has the advantage of allowing the shareholders to avoid paying taxes directly on their compensation; the corporation withholds and pays federal, state, and local taxes on salaried wages (along with the withholding amounts for Social Security, Medicare, and unemployment insurance) each time it writes paychecks.
Shareholders holding at least a majority of the corporation's stock generally approve compensation packages for shareholder-employees.
In the case of outside shareholders, state corporate law requires the salaries paid to the shareholder-employees to be reasonable in light of the job duties performed and services provided by the employees. Directors on the board who don't work for the company (outside directors) negotiate and approve the compensation amounts.
Ideally the employment compensation paid to shareholders should approximate what a typical business in the corporation's industry would pay to executives providing similar services.
Benefits and Expense Reimbursement
Typical benefits provided by closely held C corporations include family health insurance coverage, life insurance, lease payments for vehicles used at least partially for business purposes, smartphones and monthly telecom charges, laptops, and business-related travel and entertainment expenses.
To avoid both tax and corporate law violations, an expense picked up by the company should have a nexus to its business and the services provided by the employee-shareholders. For example, if an employee's duties rarely require business travel, that individual should not charge significant travel expenses to the corporation.
Obviously, charging purely personal expenses to the corporation—country club dues, children's private school tuition, housekeeping services—is not an advisable method for withdrawing money from a corporation. Blatant abuse of the IRS's business expense deduction rules expose the corporation and its directors and officers to tax and corporate law violations.
Dividends are the classic method of withdrawing funds from a C corporation, particularly for the shareholders who do not work for the company. Shareholders who own common stock in a corporation receive dividends at the discretion of the board of directors. The shareholders don't have a right to dividends, but the directors can occasionally determine that the corporation has generated excess earnings sufficient to pay a dividend. The directors must approve a common stock dividend in a formal resolution, and it usually consists of a specific dollar amount per share of common stock.
So-called preferred stock in a corporation has a built-in dividend right usually expressed as percentage of the price paid for the stock (similar to an interest rate) and functions like a combination of debt and equity. Directors do not have to approve preferred stock dividends, but most closely held corporations do not issue preferred stock.
If a corporation pays dividends during a tax year, shareholders receive Dividends and Distributions (Form 1099-DIV) and include the totals on Interest and Ordinary Dividends (Form 1040, Schedule B) with their individual tax returns.
Return of Capital Distributions
Return of capital distributions (sometimes called non-dividend distributions) are non-taxable distributions from the corporation that refund to the shareholders any capital contributions they've made to the company. If the shareholders, for example, paid start-up expenses for the company out of their own pockets, return of capital distributions are a way to repay such contributions to the shareholders.
Directors approve return of capital distributions in a formal resolution, and each recipient's total appears in Box 3 of Dividends and Distributions. Return of capital distributions reduce the shareholder's cost basis in the stock and therefore increase the amount of capital gain the shareholder realizes when selling stock.
A C corporation can lend money to a shareholder, but the terms of the loan generally require approval from shareholders holding at least a majority of the company's stock. If the corporation has outside shareholders and outside directors, they should participate in the negotiation and approve of the loan terms to minimize the risk of state corporate law violations.
To avoid creating tax liability, the loan terms should appear in a loan agreement and promissory note signed by the corporation and shareholder. The repayment terms and interest rate should reflect arm's-length negotiation between the borrower shareholder and the corporation (represented by a non-borrower shareholder or director).
Withdrawing amounts from a C corporation can raise complicated tax and corporate law issues, particularly if the company has shareholders and directors who do not work for the company. Consulting an experienced corporate or tax lawyer can help you avoid unintended legal consequences.
This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.
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