Do you have a successful business with cash reserves that you want to transfer to your personal account? It seems like it should be easy enough, but unfortunately nothing related to taxes is ever easy. Depending on the business structure, prior year earnings, and what you have personally contributed to the business, there could be a significant tax impact from transferring the money. This article goes through the common strategies used to get money out of a business and compares how they relate to the different business structures.
Strategies to Transfer Money from a Business
There are several strategies that are used to get money out of a business. Below is a general discussion of these strategies:
Distributions – A distribution is the transfer of money or property from the business to the owner. Depending on the entity type, a distribution may be treated as a return of capital, a capital gain or a dividend. A return of capital is the most tax advantageous method of taking money from a business. This treatment is reserved for sole proprietorships and passthrough entities that have basis (cash, property or recourse debt) in excess of the distribution amount. Distributions from sole proprietorships and general partnerships are always considered a return of capital whereas distributions made from a Limited Partnership, LLC or S-Corporation to an owner without basis are treated as a capital gain. Distributions made to the owners of a C-corporation are taxed as dividends, which are one of the most inefficient tax methods for getting money out of an entity. The dividends are taxed to the individual, often at a preferred rate, but the entity does not receive a deduction for the amount paid, resulting in double taxation.
Guaranteed Payment/1099 – Typically passthrough entities use this strategy. The payment is given to the owner in exchange for performing services and is treated as self-employment income, and subject to the 15.3% self-employment tax. However, the entity does receive a deduction for the amount paid to the owner, so double taxation is avoided.
Rent – If the taxpayer has a property, or room, available that can be used by the business, then the owner may be able to rent the space to the business at the fair market rate. This method can be used for any entity type other than a sole proprietorship. Rental income is taxable to the recipient, but the recipient can recognize rental expenses, including depreciation, to offset the income. The business also gets a deduction for rent expense paid.
Wages – Generally only S-Corporation and C-Corporation owners receive wages from their business, which are tax deductible for the business. The income is subject to employment taxes, which are paid by both the recipient and the business. Since S-Corporation earnings are not subject to self-employment tax, owners are required to pay themselves fair wages for any services performed for the business.
Relationship between Strategies and Business Structures
Below is a table showing the relationship between business structures and entity type:
|Strategy||Sole Proprietorship||General Partnership||LLC/LLP/LP||S-Corporation||C-Corporation|
|Distribution||Tax Free, No Limitation||Tax Free, No Limitation||Tax Free, Up to Basis||Tax Free, Up to Basis||Taxable as dividends|
|Guaranteed Payment/1099||N/A||Subject to Self-Employment Tax||Subject to Self-Employment Tax||Subject to Self-Employment Tax||N/A|
|Wages||N/A||N/A||N/A||Subject to Employment Tax||Subject to Employment Tax|
Special Situations and Other Considerations
If there are basis problems or income tax considerations preventing the use of the above strategies, here are a couple more ideas worth considering:
1. Short term financing – The business entity can loan the money to the individual. While the money will have to be repaid in some way, the loan can be done at favorable interest rates and give the taxpayer immediate access to the funds.
2. Retirement Options – An alternative method is to create a retirement account for the business owner and have the business make contributions. While this does not give immediate access to the funds, it does transfer them out of the business to the owner.
What works best for you?
There are many different variables in play when determining which strategy works best for your specific situation. If you have any question about which strategy would be the best to get money out of your business, please feel free to contact your L&B professional at (858) 558-9200.