First, let’s look at taking money out of a C corporation, also known as a C-corp. In a C corporation, the corporation will pay its own tax at a flat rate of 21% and no social security tax is paid by the corporation. So, what if you want to take money out of the corporation? You could choose to pay yourself a salary and it will be a deduction to the corporation. The problem is that you’ll now be taxed on it at your highest individual tax rate of up to 37% and your entire salary is subject to social security taxes.
If your goal is to leave a lot of money in your company to build it, then you want to be a C corporation. By leaving money in, it’s going to keep building the company and you’ll only pay at a 21% rate instead of the higher personal income tax rate.
If you take money out as a distribution, it’s going to be subject to a second level of tax. If you choose to take it out as salary, it’s going to be subject to personal income tax at your higher rate and to the social security tax. If you must take more money outside of what you’re living on, take it as salary most of the time.
If you have money for a real estate investment, choose to borrow. Remember, loans are never taxable because you owe the money back and it isn’t income to you.
So if you need to take money out as a C corporation, what’s the best way to do it? To find out, you’ll need to consult a good CPA who can advise you and explain the numbers. They need to help you minimize your income tax and your social security tax and reduce your taxes overall.
And remember, NEVER pay for personal expenses out of your business. This is called commingling your funds. If you do this, you run the risk of jeopardizing your corporation’s existence for legal purposes. Remember, consult your accountant and discover the right way to take money out of your business. The right way to take money out is through a loan, a distribution, or a salary, and the right one to choose depends on your specific situation. The more you can leave in your C corporation, the better off you are because the C corporation is taxed at a flat 21% rate.
Let’s say you want to take most of your money out of your corporation because that’s what you need to live on. In this case, you would be better off forming an S corporation, also known as an S-corp.
As an S corporation, you’ll still pay income tax on 100% of the income earned by the S-corp, but no social security tax is paid by the corporation. As an S corporation, when you take a salary from your corporation, there will be social security taxes on that salary. To reduce your taxes, minimize your salary. This salary of course needs to be reasonable and what you would pay somebody else to do your job.
One of the differences between an S-corp and a C-corp is that the C-corp has two taxes, one at the corporate level and one at the individual level as a dividend. The S corporation has only one level of tax, which is the income tax. Remember, the distribution on an S-corp is not subject to social security taxes as long as you’re paying yourself a reasonable salary. Discuss this with your accountant to determine what a reasonable salary is.
Now, what about the rest of the money?
In many cases, you can take out the rest of the money as a distribution. An exception is if the money you’re taking out came either from you putting money in as a loan to the company or if the company borrowed money from someone else. If this is the case and you distribute that money, you could have a capital gain when it’s distributed out of the corporation. Once again, it’s immensely important to discuss with your CPA the best way to take money out of your company.
As with a C corporation, it is extremely important that you NEVER use business money to pay for personal expenses. If a large personal expense arises, borrow the money from your business. Take it out as a loan. NEVER commingle funds or you could lose the protection of the corporation if a lawsuit happens. If you were to commingle funds and be hit with a lawsuit, you might have to pay money out of your own personal assets.
So now you know there is a right way and a wrong way to take money out of your business. It can have major tax and asset protection consequences. If you have an S corporation, take money out as a distribution when appropriate to avoid tax consequences. For C corporations and partnerships, consult your accountant. Discuss your budget with your accountant. Determine what you will need for the year for personal expenses, and the rest will be for investments.
Remember to maintain good records. Always document when you take money out. Educate your bookkeeper on how to record the money that is coming to you. Also, regular discussion with your CPA will allow you to learn the right way to take money out of your company and maintain asset protection. When you do these things, you’ll end up with way more money and pay way less taxes.
Want to learn how TFW Advisors® can help you reduce your taxes and increase your wealth? Book a call with us today!