If you’re a U.S. based small business owner, you might already have heard about double taxation: when the same income is taxed once at corporate level, and then again at an individual level when the distribution of profits as dividends takes place. A significant concern for owners of C-Corporations in particular, this situation can quickly become a financial burden and impact a company’s ability to grow and reinvest profits.
However, by understanding the way in which double taxation works, and with guidance from an accounting firm in Miami, small business owners can identify strategies for avoiding it, and become more financially efficient.
Here are some strategies you may wish to discuss with your accountant:
Selecting the right entity structure
Undoubtedly one of the best ways to avoid double taxation, is by selecting a business structure that doesn’t have to deal with the issue at all. Below are some alternative structures you may wish to consider:
- S-Corporation – with income passed through to shareholders, and then taxed at their individual rates, S-Corporations can cut out a layer of taxation, and avoid federal corporate income taxes altogether.
- Limited Liability Company, or LLC – although the majority of LLCs choose pass-through taxation as a partnership or sole proprietorship, in which the income of their business is reported on their personal tax returns, LLCs can also opt to be taxed as S or C-Corporations.
- Partnership – enjoying pass-through taxation, partnerships are similar to LLCs, with their company’s profits taxed at the individual partner level only.
Retaining earnings
Instead of their earnings being distributed as dividends, C-Corporations can hold on to them, meaning that the corporation then pays tax on them, while the shareholders avoid having to pay personal tax on dividends. In this way, double taxation is mitigated.
But it’s worth noting that this particular strategy can be trickier than it seems, and expert guidance from a tax specialist can help ensure that you’re not hit by an accumulated earnings tax from the IRS.
Paying salaries to owners
Because salaries can be deducted as a business expense – helping to reduce corporate taxable income – paying a salary to owner-employees can help you bypass double taxation. With this strategy, income is taxed only once as personal income for whoever is receiving it, but note that salaries must be deemed reasonable if IRS scrutiny is to be avoided.
Using fringe benefits
Fringe benefits that are tax-deductible, such as retirement plans, health insurance and education assistance, can be offered to owner-employees by C-Corporations. Because they’re considered deductible for the company, but not taxable income for employees, double taxation can be avoided.
Borrowing rather than distributing dividends
Instead of receiving dividends from the company, shareholders can receive loans, helping to defer tax liability for personal income. It’s important to note however, that in order to prevent the IRS reclassifying the loan as a dividend, it must be a legitimate loan that can reasonably expected to be repaid.
Reinvesting profits
With help from Coral Gables accountants, businesses can reinvest their profits into growth initiatives such as research and development, or expansion, to lower their taxable income at corporate level, and reducing the impact of double taxation.
Although it can be a serious challenge for small businesses, avoiding double taxation altogether, or at the very least, mitigating its effects, is possible by implementing financial strategies recommended by an experienced accountant.