Controller Services – If you need to withdraw funds from
your controlled corporation, you can structure the withdrawal so that it is not
subject to tax as a dividend. While dividends are generally taxed to
non-corporate shareholders at capital gains rates, a loan from a corporation to
its shareholder is not subject to tax. However, even though no dividend has
been declared, IRS can treat shareholder withdrawals of cash from a corporation
as dividends, if they aren't structured properly.
A Tax Court case
demonstrates what can happen when a shareholder isn't careful and treats a
controlled corporation as though it were a personal bank account. In that case,
a husband and wife wholly owned the corporation. The husband, Michael, ran the
corporation, and dealt with it very informally. He took money out as needed for
personal expenses, and received a $100 check along with each weekly paycheck. Michael
and the corporation accounted for these withdrawals as “shareholder advances,”
and both Michael and the corporation showed these advances as loans on
financial statements that were given to third parties. At the end of every
year, part of the outstanding balance of the shareholder advances account was
repaid by crediting Michael's year-end bonuses against it. On audit, IRS
determined that the shareholder advances weren't true loans, and treated them
as dividends. The Tax Court agreed that the withdrawals were dividends and that
the year-end repayments didn't establish existence of a true loans because
there was no written agreements obligating Michael to repay the advances, the
loans had no maturity date, no ceiling and no security, and the corporation had
earnings and profits, but never made dividend distributions.
There are about a dozen
factors that the courts look at to decide if a shareholder withdrawal is a loan
or a dividend. Most of these are within your control. One important factor, for
example, is whether there is a written promissory note. It isn't necessary that
each of the factors point to a loan, but taken together they must be sufficient
to establish that the withdrawal is not a dividend.
I would be happy to
examine your dealings with your corporation. Where appropriate, I can help you
structure withdrawals and other transactions with your corporation to alleviate
the risk that your withdrawals will be subject to tax as dividends. If you
found this Tax Tip helpful, please share it through your social media platforms.
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