Academic journal article Journal of Accountancy

From the Tax Adviser: Time to Distribute Corporate Earnings? Taking Advantage of the Lower Tax Rate on Dividends Received

Academic journal article Journal of Accountancy

From the Tax Adviser: Time to Distribute Corporate Earnings? Taking Advantage of the Lower Tax Rate on Dividends Received

Article excerpt

The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) reduced the individual tax rate on corporate dividends received to 15% for individuals in the 25%, 28%, 33% and 35% tax brackets (5% (0% in 2008) for individuals in the 15% and 10% income tax brackets); this affords some planning strategies for closely held corporations that want to reduce their accumulated earnings and profits (E&P). CPAs should become aware of some of these opportunities.

OVERVIEW

The bane of corporate taxation always has been the double taxation of corporate earnings. So, this may be a good time for some corporate taxpayers to minimize ("bail out") E&P by distributing dividends that will be taxed at the post-JGTRRA rate.

REDUCING E&P

The goal of the planning techniques below is to distribute earnings as dividends during the period of lower tax.

Excess compensation issues. Closely held C corporations traditionally have maximized salaries to officer-shareholders to reduce corporate taxable income. Under IRC section 162(a)(1), the IRS often seeks to treat a portion of a share holder's salary as a nondeductible constructive dividend if it is excessive or unreasonable. With the lower rates on dividends, corporations might want to pay compensation as dividends, not salary, to avoid this issue. Even excess salary reclassified by the IRS as a dividend will be taxed to the shareholder at a lower rate.

AE tax. Section 531 of the tax code provides an additional tax on a C corporation's accumulated taxable income; the pre-JGTRRA rate was the highest individual income tax rate. The accumulated earnings (AE) tax is a penalty for accumulating E&P beyond a business's reasonable needs. …

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