A corporation can deduct the compensation that it pays, but not its dividend payments. Thus, if funds are withdrawn as dividends, they’re taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is taxed only once, to the employee who receives it.
However, there’s a limit on how much money you can take out of the corporation in this way. The law says that compensation can be deducted only to the extent that it’s reasonable. Any unreasonable portion is nondeductible and, if paid to a shareholder, may be taxed as if it were a dividend. As a practical matter, IRS rarely raises the issue of unreasonable compensation unless the payments are made to someone “related” to the corporation, such as a shareholder or a member of a shareholder’s family.
How much compensation is “reasonable”? There’s no simple formula. IRS tries to determine the amount that similar companies would pay for comparable services under like circumstances. Factors that are taken into account include:
There are a number of concrete steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation. For example, you can:
As in most tax situations, planning ahead avoids problems later. Contact our office today to discuss this or any other aspect of your current or deferred compensation strategies.
By: Theresa A. Smith
Education costs are on the rise, but you will be happy to know there are education tax deductions and credits that can help offset the costs.
Work related education expenses:
A deduction is available if the education maintains or improves the skills related to your trade or business. Educational costs are also deductible if the education is required to keep your position or job. Work related educational costs are not deductible if the education is required to get into the field or qualifies you for a new trade or business. If your educational costs are deductible under these tests, you can include the transportation costs involved. If you’re away from home for deductible education, you can include the costs of travel, meals (at 50%), and lodging as well. In the case of an employee, education expenses that are deductible under these tests may be claimed as an itemized deduction, but only to the extent the expenses, along with other miscellaneous itemized deductions, exceed 2% of the taxpayer’s adjusted gross income (AGI).