Dividend Tax Rate Cuts Benefit Closely Held Corporations

By Korb, Phillip J.; Sigler, John N. et al. | The CPA Journal, October 2004 | Go to article overview

Dividend Tax Rate Cuts Benefit Closely Held Corporations


Korb, Phillip J., Sigler, John N., Vermeer, Thomas E., The CPA Journal


On May 28, 2003, President Bush signed into law the Jobs and Growth Tax Relief Reconciliation Act. One provision was to reduce the individual income tax rates on dividends to 15% (5% if the taxpayer is in the 10% or 15% income tax bracket). To qualify for these reduced rates, the dividend must be received from a domestic corporation, a foreign corporation whose stock is traded on an established U.S. securities market, or a foreign coiporation based in a country that has signed a tax treaty with the United States. To be eligible for the reduced rates, a shareholder must have held the stock for at least 60 days in the 120-day period beginning 60 days before the ex-dividend rate. Similar to the reduced capital gains rates, the reduced rate of 15% also applies in computing the alternative minimum tax (AMT).

As with many recent tax law changes, the reduced tax rates on dividends are scheduled to sunset after a limited period of time (December 31, 2008). Political factors could also lead to the repeal of these changes before the sunset date. Taxpayers that can benefit from these changes now should take advantage of them while they are still law.

Closely Held C Corporations

One kind of taxpayer that can benefit from the reduced tax rates on dividends is an owner/employee of a closely held C corporation. Four situations where an owner/employee of a closely held C corporation can benefit from the reduced tax rates on dividends are described below.

Bonuses and dividends. Typically, a closely held C corporation has avoided double taxation either through reducing a majority of its profits by granting a bonus to its owners/employees or through deferring the second tax by leaving the profits in the corporation as accumulated earnings. In fact, many recent tax court cases related to closely held C corporations involve either the recharacterization of a bonus as a nondeductible dividend or the nonpayment of sufficient dividends relative to profits, which subjects the C corporation to the accumulated earnings tax.

With the reduction in tax rates on dividends, a closely held non-personal service C corporation should consider distributing a greater portion of its profits as a dividend rather than as a bonus. By distributing a larger portion of its profits as a dividend, a closely held C corporation can take advantage of the lower corporate income tax rates for taxable income under $75,000 and can reduce its payroll taxes. For exampie, if a closely held C corporation normally reduces its taxable income to zero by providing the sole owner/employee an annual bonus of $150,000, the taxes paid by the C corporation and the owner/employee total $72,000. However, if this same C corporation decides to pay the sole owner/employee a bonus of $75,000 and distribute the remaining $75,000 as a dividend, the total taxes paid by the C corporation and the owner/employee are $61,000, a total tax savings of $11,000 (see the Exhibit).

A closely held C corporation should consider certain issues before adopting this strategy. First, tax courts have scrutinized year-end bonuses to an owner/employee because of the possibility of a disguised dividend. With the reduction in the tax rates on dividends, tax courts will probably scrutinize closely held C corporations that have traditionally paid a large bonus and no dividend but have switched to the payment of a large dividend and no bonus since the dividend tax rates were reduced. Thus, it is important that a corporation develop an incentive plan that includes a predetermined formula for bonuses. This plan should be logical and should be approved by the board of directors. An arbitrary payment of a dividend based on cash available will likely draw scrutiny from the courts.

Second, a reduction in a bonus could significantly impact the retirement plan contribution of the C corporation on behalf of its owners/employees. Third, the reduced tax rates on dividends are expected to expire in 2008; it will be difficult to dramatically increase salaries when the tax rates on dividends increase again in 2009. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Dividend Tax Rate Cuts Benefit Closely Held Corporations
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.