Q: I am a part-owner in a closed corporation, a mechanical-repair business in the state of Maryland. There are four stockholders, all family members. How do we take income from the business without being double-taxed? And what kind of a business expense would I consider it to be?
A: There are three ways to take income out of a corporation without incurring a double tax.
1. If all the shareholders work for the corporation, you should be able to take out a large portion of income as wages during the year. The IRS restricts wages to reasonable compensation, but you may be able to argue that the shareholders' services generate the majority of income and therefore should result in higher wages.
2. Director's fees are another possible solution. If one or more of the shareholders does not work for the company but advises the company throughout the year, that shareholder may be due a Board of Director's fee for his or her services.
3. The third possibility will take a little planning. It is possible to change your corporation to what's called an "S-Corporation." S-Corporations have the same liability protection as C-Corporations (a C-Corporation is the type you have now), but they are not taxed twice. S-Corporation income is distributed to the shareholders based on their ownership percentage. The shareholders each pay a portion of the company's tax on their own 1040. This is the only time tax is paid on the corporation's income.
Changing from a C-Corporation to an S-Corporation is a complicated matter, and you'll need to consider more than just the issue of double taxation before making any changes. Your tax adviser should be able to explain all the issues involved in switching to an S-Corporation.
Kevin Boeving, CPA
Poppen & Associates, CPAs, P.C.
St. Louis, Missouri
Editor's note: While the information in Tax Adviser represents the opinion of an expert, it is not legally binding.
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