Expert: Vanessa D. Powell, CPA - 12/28/2009

Question
Vanessa - My partners and I are small company owners - share holders - and employees - we are always struggling with looking good for the bank on the bottom line and having to borrow cash to pay the taxes on the profits shown. Especially this year with the way credit is shrinking.  We are a C corporation and we basically do our own books - but I was the president of another C Corp which was a division of a much larger corporation around 20 years ago with a army of .  I believe the way they worked around this problem was to show half of our salaries as payroll and the other half as disbursement of profit - therefore when we showed our P%26L to the bank we had half our pay in the profits - then when we went to file our taxes we disbursement the balance to the share holders.  Am I correct - is this a legal and good way to handle this dilemma???  Thanks Dave  

Answer
Hi Dave-

What you describe is a kind of "middle-of-the-road" method to paying officers.  There are three issues at hand here.  The first is needing to show a good profit in order to receive financing.  The best way to do that is to make distributions through equity (i.e. dividends.)  These do not show up on the P%26L, but rather on the balance sheet.  However, this creates a larger tax liability for the C-Corp, which is the second issue.  So it may be beneficial to pay out some money as salary, in order to reduce the profit.  The third issue is that any amounts paid as dividends will be taxed twice- once at the Corporate level and once at the individual level.  This is because dividends are taken out of equity (which is why they don't show up on the P%26L) which is made up of profits that have already been taxed.

This is why some corporations choose to do a little of both.  During planning for the coming tax year, they decide how much the corp will pay shareholder/employees in salary so that they show just enough profit for the bank to approve financing and the rest is paid as dividends.

Just as a side note- the shareholders (as well as the corp) need time to plan for this method so that they can make estimated payments for their personal tax liability, as dividends have no withholding.

Let me know if you need any further clarification.  Happy holidays!
Vanessa