Paying dividends and wages in a C corp

[Dean241]

I am in California, and I am thinking of forming a C corporation because I do not plan on making any significant amount of money and the idea of being able to put money back into the business without it being initially taxed in the form of retained earnings etc is appealing.

I know this question has been asked multiple times, but I still am having trouble understanding.
My question is:

Is it possible to reinvest ALL of my money back into the corporation without paying any initial taxes on it until wages are paid or distributed?

In other words, if I make a small amount of income, let's say $10,000, can I choose to withhold accepting a wage as an officer, if so, how would I go about doing so? Would I have to create some form of legal document similar to a deferred compensation agreement?

Or is the only option to pay myself a fair wage or dividends, then pay tax on the $10,000 minus the deductions, and then hold the excess income as retained earnings?

[tagteam]

C corporations are entirely separate and distinct taxable entities; they pay income tax on their taxable income, regardless of how that net income is utilized.

If the C corporation pays you a salary of $10,000, the corporation's taxable income would be reduced by that amount and it would issue a W-2 at the end of its tax year which, in turn, you would report on your individual income tax return (1040).

[Dean241]

My question was can I choose to withhold accepting a wage as an officer, if so, how would I go about doing so? Would I have to create some form of legal document similar to a deferred compensation agreement?

Or is the only option to pay myself a fair wage or dividends, then pay tax on the $10,000 minus the deductions, and then hold the excess income as retained earnings?

In other words, if the corporation makes $10,000 net income is there any legal way that I can just keep that income within the corporation without paying myself a wage as an officer even though I worked full time for the corporation?

Just to confirm, you saying that is not possible to keep the income within the corporation if I can find a legal way to not pay myself a wage by using some legal arrangement such as deferred compensation?

[tagteam · Accepted solution]

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@Dean241 wrote:

In other words, if the corporation makes $10,000 net income is there any legal way that I can just keep that income within the corporation without paying myself a wage as an officer even though I worked full time for the corporation?

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You can certainly retain the $10,000 within the corporation without paying yourself a wage or salary, but the corporation will have to pay federal income tax on its taxable income. 

In other words, there is no way you and the corporation can not pay federal income tax on the net income of $10,000 (either the corporation will pay the IRS or the corporation can pay you a salary and then you will pay the IRS).

[Dean241]

Alright, thanks! I just wanted to check. Thanks for clarifying that for me. 

[Mike9241]

can a C-corporation owner/employee not take a salary?

If the company is a C Corp, there is no requirement that the corporation pays owner/employee a salary. However, there are IRS guidelines that should be followed. The IRS has said that if a C corporation is distributing profits to its owners and has not hired any other employees, it should follow the 60/40 rule. This rule states that 60 percent of the distribution should be treated as salary—and thus subject to payroll taxes—and the remaining 40 percent as dividends.

and here's the link to it

https://solvencynow.com/2021/01/28/should-the-business-owner-be-on-payroll/#:~:text=If%20the%20compa... 

Thus taking a dividend without a salary could possibly result in a recharacterization by the IRS. 

Nor can a C-Corp accumulate profits forever without paying dividends or salary.  IRC section 531 comes into play:

In addition to other taxes imposed by this chapter, there is hereby imposed for each taxable year on the accumulated taxable income (as defined in section 535) of each corporation described in section 532, an accumulated earnings tax equal to 20 percent of the accumulated taxable income. (In its simplest form taxable income is reduce by the regular taxes and the net its then subject to a 20% tax). This doesn't bar the IRS from reclassifying dividends as compensation.

basically, there is no 531 tax on the accumulation of earnings for the reasonable needs of the business of not less than $250,000. (IRC 535).  

[Dean241]

Hi Mike,

Thanks for your response. I was just confused off of an article that I read on upcounsel that was written which claimed that:

"After paying its bills and debts and distributing profits to shareholders and owners, the C corporation can invest the remaining funds in the company. This reinvested amount is a type of equity called retained earnings.

Corporations are required to pay income tax on their profits after expenses. If no profit is recorded, no income tax is paid. Retained earnings can be kept in a separate account and are tax-exempt until they are distributed as salary, dividends, or bonuses"

For some reason I incorrectly interpreted the "if no profit is recorded" as "if no wages or distributions are made no income tax is paid", that the profit could be classified as retained income.

Now I understand that retained earnings are whatever money is left AFTER taxes are initially paid on the year's profit. 

Thank you both the clarification.