- The term “double taxation of dividends” refers to the way the US government taxes corporate earnings and dividends.
- Corporations pay taxes on their earnings before paying dividends to shareholders from the after-tax earnings.
- Because of this obligation, some firms choose to reinvest profits rather than pay dividends to shareholders.
Do you pay Corporation Tax on dividends?
As long as your company has adequate distributable profits, you can receive dividends at any time during the year. Payments are usually made once a month or once a quarter.
HMRC may perceive frequent payments as disguised salary, which is a typical worry among contractors with whom we engage. To stay out of HMRC’s bad books, make sure you keep accurate records and have the proper paperwork in place.
Maintain a clear audit trail by keeping your salary and dividend payments separate. If HMRC decides to open a tax investigation, you’ll be able to show that nothing is wrong and that you’ve followed the rules.
Do note that dividends can’t be received from contracts that fall inside IR35. Refer to our thorough guide on IR35 for more information on off-payroll working rules and what they mean for contractors.
What else can I do with dividends?
Dividends might be put into a pension fund, an ISA, or given to family members.
You’ll have to examine the advantages and disadvantages of each option, as well as the tax and legal ramifications. This is a complicated decision that should be made after speaking with an accountant.
Key dates you need to know
The date on which a company’s board of directors announces the details of a dividend payment, such as the dividend amount, the date of record, and the payment date.
A cut-off date is used to determine who is on the share register and hence eligible for dividend payments.
To put it another way, an individual must be a shareholder by the record date in order to collect the dividend. On average, the record date falls on a Friday.
The ex-dividend date, also known as the ex-date, is the last day on which an individual must own shares in order to be eligible for the next dividend.
The payout will go to the seller if an investor buys shares on or after the ex-dividend date. The ex-dividend date is usually set one working day before the record date, hence it usually falls on a Thursday.
Dividends can’t be paid out if a company is losing money
Dividends can only be given out of earnings produced during the year or from previous years’ gains. Salaries, on the other hand, can be paid even if a company is losing money.
Paying a dividend doesn’t reduce your company’s corporation tax bill
Companies pay Corporation Tax on their income before they distribute dividends, therefore paying a dividend has no impact on your corporation’s tax bill.
Salaries, on the other hand, are considered business expenses. This lowers your profit and, as a result, your Corporation Tax.
Creating different classes of shares can be an option worth exploring
Creating multiple classes of shares could be an option to consider so that both categories of partners do not receive the same dividend rate.
Timing is key
When it comes to how often dividends are given out, there are no hard and fast regulations, and this is something you should think about carefully.
- It has the potential to affect the amount of tax you pay: Dividends can help you balance your profits from one year to the next, allowing you to avoid being placed in a higher tax bracket. If your profits are £55,000 in the first year and £10,000 in the second, you can declare a lesser dividend in the first year to pay the basic rate in both years rather than the higher rate in the first.
- It has the potential to affect your HMRC deadlines: Dividend income tax is due in January following the tax year (6 April – 5 April) in which the dividend was distributed. This means that if you received a dividend in February 2020, you’ll owe tax in January 2021. The tax will be owed in January 2022 if the dividend was paid out in May 2020.
Your personal pension can be affected
Dividend income (rather than a salary) can help you save money on taxes.
However, it’s crucial to remember that finding a job will effect your personal pension because earning a paycheck increases the amount of money that may be put into your personal pension.
If you want to contribute to a personal or executive pension plan, we recommend speaking with your accountant about any minimum salary requirements that may be in place. You might also want to talk about if establishing a company pension plan is something you should think about.
Dividend paperwork
You must prepare a dividend voucher for each dividend payment made by the company, which must include the following information:
You must provide each dividend recipient a copy of the voucher and preserve a copy for your company’s records.
Do you pay corporation tax before or after dividends?
It isn’t the case. Before dividends are given out, a corporation pays Corporation Tax on its profits. As a result, shareholders’ dividends are treated as if they had already paid tax on them (known as a ‘tax credit’). Dividends will be added to a shareholder’s income if they pay Higher Rate Tax, and they will owe more tax.
Dividends have the advantage of saving you money on National Insurance when compared to salaries. A bonus received through salary, for example, will be subject to Employer’s NI of 13.8 percent (plus any PAYE and Employees NI due), whereas a Dividend will not be subject to NI. This is one of the main reasons why small business owners prefer to pay themselves low salary and then receive their ‘bonus’ in the form of dividends.
Are dividends deducted before corporation tax?
Although corporations are not permitted to deduct dividend payments before taxes, there is an alternative: a business structure known as an income trust. Dividends, or trust payments, can be deducted before taxes are calculated with income trusts.
Do limited companies pay corporation tax on dividends received?
A variety of exclusions may be available to a UK holding company, making it an appealing possibility in certain circumstances.
Tax treatment of payments made by a UK holding company to investors
In the event of debt financing, the UK holding company is likely to repay money to investors in the form of interest, or dividends in the case of equity financing.
Debt and interest
The UK holding company may be eligible for a corporation tax deduction on interest payments to investors, albeit these payments may be subject to anti-avoidance regulations, such as transfer pricing, which is detailed below. These anti-avoidance regulations are complicated, and they could prevent the UK holding company from deducting any taxes.
The UK government plans to enact a broad rule limiting a company’s ability to deduct interest expenses from its taxable profits.
The new rule is set to take effect in April 2017 and would limit interest tax deductions based on a preset ratio that represents a proportion of a company’s earnings before interest, taxes, depreciation, and amortization (EBITDA).
The administration issued information on how the new rule would work in May 2016. The rule will include a fixed ratio of 30% of tax EBITDA, a £2 million de minimis threshold, and a narrowly limited exception for third party interest expenses on specific public benefit infrastructure projects, according to the current proposal.
The new interest limitation law is the product of an initiative by the Organisation for Economic Cooperation and Development (OECD) to combat “base erosion and profit shifting” (BEPS).
The BEPS effort aims to address the artificial shifting of profits of multinational corporations to low-tax jurisdictions and the exploitation of tax system mismatches to avoid paying tax.
The OECD concluded that interest deductibility created a BEPS risk and recommended the implementation of a general interest limiting regulation in October 2015.
Withholding tax on interest
In general, a UK holding company is required to withhold tax (currently 20%) on UK source interest payments to investors. If tax is withheld, it must be paid to HM Revenue & Customs (HMRC) in order to account for the investor’s UK tax liability. Investors can then obtain a refund of the tax deducted from HMRC in certain circumstances.
There are a few exceptions to this general norm when it comes to withholding tax. Payments of interest to UK banks and UK company taxpayers, for example, are currently exempt from withholding tax.
In addition, quoted Eurobonds are immune from UK withholding tax. A quoted Eurobond is a debt asset with an interest right that is listed on a recognized stock exchange.
A new exemption has been provided for certain qualifying private placements since January 2016. A private placement is an unlisted debt instrument that is sold to a select group of investors through a private offering.
If a non-UK resident investor is based in a nation having a double tax treaty with the UK, there may be no need to withhold tax if the investor is based in a place where no UK tax is payable on interest paid to a resident of that country. A lower rate of withholding tax may be provided under a double tax treaty. Even though a double tax treaty exists, the holding company cannot make payments to investors without deducting tax or withholding tax of less than 20% unless it has secured HMRC approval to pay investors without withholding tax.
Tax treatment of payments received by the UK holding company from its subsidiaries
Dividends received by the UK holding company from other UK firms or from foreign corporations should qualify for a dividend exemption from corporation tax. If this option is available, the UK holding company will be exempt from paying corporation tax on the profits it receives.
The dividend exemption will be available to the UK holding company if it is classified as a’small’ firm. A firm is considered tiny if it employs fewer than 50 people and has an annual turnover or balance sheet of less than €10 million. For the purposes of these limits, any related firms, such as subsidiaries of the holding company, must have their personnel, turnover, and balance sheet added to that of the UK holding company.
If the holding company is a small business, the dividend exemption should prevent UK tax from being paid on dividends given to it by UK firms or companies based in most countries with which the UK has a double tax treaty, as long as a few other conditions are met.
If the holding company is not a small business, the dividend exemption may still be available if the dividend is paid by a firm that the holding company owns, as long as certain other requirements are met.
Controlled Foreign Company rules
Anti-avoidance measures, known as the controlled foreign company (CFC) rules, prevent a UK business’s income from being artificially diverted to subsidiaries or other corporate entities in low-tax jurisdictions in order to avoid paying UK corporation tax.
A CFC is a business that is tax resident outside of the United Kingdom but is owned by one or more UK citizens.
The rules may impose a corporation tax charge on a UK resident company in connection to certain CFC profits in specific circumstances.
A CFC charge is not imposed if certain conditions are met. CFCs that are located in a jurisdiction with a headline corporation tax rate of more than 75% of the UK corporation tax rate, for example, are exempt under specific conditions (currently 20 percent ). The UK’s CFC regulations are complicated, and where they apply, tax counsel should always be sought.
Transfer pricing
When services or transactions are provided between related parties for a price determined to create a UK tax advantage, the transfer pricing anti-avoidance regulations apply. The restrictions also apply to the terms of loans made between parties who are connected. The restrictions have the effect of treating products and services as being supplied to or by UK corporations for their “arm’s length price,” rather than the actual fee.
When entering into transactions with other companies in its group, a UK holding company may need to examine the implications of certain restrictions. The laws may also disallow or limit a tax deduction for interest paid by the holding company to its investors, depending on the circumstances.
Large corporations are exempt from the rules, whereas small and medium-sized businesses are not. They apply to cross-border transactions as well as those involving UK residents.
Diverted Profits Tax (DPT)
DPT is a new UK tax aimed at multinational corporations operating in the UK that are suspected of diverting revenues out of the country to avoid paying corporation tax in the UK. In April of 2015, DPT was introduced. It is not applicable to small and medium-sized businesses.
DPT is currently at a rate of 25% of the diverted profit. In general, DPT is used in two situations:
- where a group has a UK subsidiary or permanent business and there are arrangements between associated parties that “lack economic substance” in order to take advantage of tax mismatches One example would be if earnings were taken out of a UK subsidiary through a large tax-deductible payment to an affiliated entity in a tax haven; or if profits were taken out of a UK subsidiary through a large tax-deductible payment to an associated entity in a tax haven.
- When a non-UK resident company engages in activity in the UK in connection with the supply of goods, services, or other property, and that activity is designed to prevent the non-UK company from establishing a permanent presence in the UK, and either the main purpose of the arrangements is to avoid UK tax, or a tax mismatch is secured, the total tax derived from UK activities is significantly reduced.
There are certain exemptions from the DPT charge if UK-related sales are less than £10,000,000 or UK-related expenses are less than £1,000,000 in a 12-month accounting period.
If the corporation has made transfer price adjustments in the relevant transactions that put it in the same tax position as if arm’s length pricing had been applied, there should be no DPT charge.
Calculating a DPT charge is complicated, and there are several rules to consider.
If a UK holding company believes DPT may be applicable to its business, it should always seek professional tax advice.
Patent box
The patent box regime for intellectual property taxation in the United Kingdom was implemented in April 2013.
In general, the regime permits certain UK-based companies to decide to pay a lower corporation tax rate on earnings obtained from patented discoveries (and certain other innovations).
The reduction was phased in over four years, resulting in a 10% corporation tax rate on April 1, 2017.
The patent box, however, will close to new applicants on June 30, 2016, and will be phased down for existing claimants by June 30, 2021.
As part of the BEPS project, HMRC produced draft legislation in December 2015 to update the design of the patent box to comply with OECD recommendations.
From July 1, 2016, a new UK Patent box based on the “modified nexus” technique will be accessible.
This method looks more closely at where the money spent on research and development to generate the patent or product actually goes.
Exit strategy
Sale of subsidiaries by the UK holding company: The UK holding company may decide to sell its subsidiaries’ shares and distribute the proceeds to shareholders as a dividend. When the shares are sold, there will very certainly be a capital gain on which corporation tax will be due. The UK holding company may be eligible for a tax break known as the substantial shareholding exemption (SSE), which exempts the whole income from capital gains tax.
Several conditions must be met in order to qualify for this exemption. These requirements are lengthy, but they include the need that the company hold at least 10% of the shares for at least one year. Both the UK holding company and the subsidiary it is selling must be trading firms, and their activities cannot include activities other than trade to a significant level. These requirements must be met both before and after the shares are sold. There are a number of other standards that must be met, which means that each transaction must be thoroughly examined to determine whether the SSE is accessible.
The gains will not be taxed in the hands of the holding company where the SSE is available, thus there should be more monies available to return to investors.
If investors sell their shares in a UK holding company, any chargeable gain will be liable to capital gains tax unless the person selling the shares is not a UK resident.
Should I pay myself in dividends or salary?
Your company should be a S corporation to get the most out of the salary/dividend plan. Dividend payments, unlike wage payments, cannot be deducted from a company’s current income. This means that a standard C corporation must pay corporate level tax on any dividends it pays out. The tax on $20,000 in the example above would be $3,000, wiping out any overall savings. You can avoid this outcome by electing S corporation status. True, you’ll have to pay taxes on the dividend income, but your company won’t have to.
Allocation of income to dividends must be reasonable
Why not eliminate all employment taxes by removing the salary element and just accepting a dividend if you can save around $1,600 in employment taxes by paying yourself a $20,000 dividend? “Pigs get fed, but hogs get butchered,” as the saying goes. “If it seems too good to be true, it probably is?” or “If it seems too wonderful to be true, it probably is?”
Transactions between shareholders and their S corporation are rigorously scrutinized by the IRS, especially if they have the potential for tax avoidance. The more stock you own and the more power you have over the company, the more scrutinized the transaction will be. If the payments are contested, the IRS will investigate whether you are performing significant work for the company. If you’re doing a lot of labor, the IRS will expect you to be paid a “reasonable” wage for the sort and quantity of job you’re doing. It will also reclassify the “dividend” as a salary and issue a bill for unpaid employment taxes to the corporation.
Prudent use of dividends can lower employment tax bills
You may considerably lessen your chances of being questioned by paying yourself a decent income (even if it’s on the low end of reasonable) and paying dividends at regular times throughout the year. You can also reduce your overall tax liability by reducing your employment tax liability.
Forming an S corporation
An S corporation is simply a regular company that has filed a special tax election with the Internal Revenue Service. To begin, you must register your business with the state. Then you must file Form 2553 with the Internal Revenue Service, explaining that you are electing S company status with pass-through taxation.
It can be tough and costly to reverse this decision after you’ve made it. You’re also bound by the corporate procedures that every corporation must follow, such as holding board of directors meetings, recording minutes, filing periodical reports, and so on. However, you will be rewarded with a lesser tax bill.
How do dividends affect corporation tax?
A dividend is a payment made from your company’s earnings after taxes have been deducted. That is, the money made in your firm is first taxed at the corporate tax rate, and then the after-tax profits are distributed to you as a dividend.
What is corporation tax based on?
A tax definition for a corporation It is calculated using a company’s annual profits. Although all profits are taxable, certain particular expenses can be deducted, and there are allowances you can employ to help lower your tax bill.
Are overseas dividends subject to corporation tax?
The great majority of dividends from international companies are tax-free in the United Kingdom. Under the domestic law of the paying country, foreign profits are frequently subject to a Withholding tax (WHT) deduction.
How do you pay yourself from a corporation?
We work with business owners all around Canada, and we’re frequently questioned about the distinction between compensation and dividends. You can pay yourself a salary, dividends, or a combination of both if you own a firm through a corporation.
The differences between salary and dividends, as well as the key pros and disadvantages of each, will be discussed in this article. We’ll also look at some common instances in which a business owner would opt for one strategy over the other.
TYPE OF TRANSACTION
If you pay yourself a salary or wage (the same thing), the payments become a business expense and then personal employment income – you’ll obtain a T4. The expense lowers the corporation’s taxable revenue, lowering the amount of corporate taxes due.
HOW IT’S DONE
The corporation will need to open a payroll account with the CRA in order to pay yourself a wage. The corporation will be required to withhold source deductions (CPP and Income Tax) from your pay each time you are paid. The Receiver General (CRA) receives these source deductions on a regular basis. In addition, the company must prepare and file T4s for every employees who earned wages each year.
Here’s all you need to know about setting up a payroll account and submitting source deductions.
WHY CHOOSE SALARY
You can make a consistent and predictable personal income by paying yourself a wage. Using this strategy has a number of major advantages, including:
- RRSP Contribution Room – You can build RRSP contribution room by paying yourself a paycheck, but not by giving yourself dividends.
- Contributions to the CPP – This is a two-edged sword. You will be able to contribute to the Canada Pension Plan with your wages (dividends do not). This means that you will gain in the future if you collect CPP, but it also means that CPP contributions are a cost to both you and the company. Less money now, more money tomorrow.
- Income tax is withheld from each payment and submitted to the Receiver General, resulting in fewer unexpected tax bills. You will have already paid income tax when you file your personal tax return, avoiding an unexpected personal tax bill. When dividends are paid, income tax is not withheld or remitted, resulting in personal tax liabilities in April.
- When Applying for a Mortgage – When applying for a mortgage, lenders prefer to see consistent, predictable income. Employment income, on the other hand, will assist demonstrate a consistent income, although dividend income may not be seen as favorably.
Dividends are payments made to shareholders of a corporation from the company’s after-tax earnings. Dividends are not a company expense, and therefore do not reduce the amount of corporation taxes owed. Dividends, on the other hand, have a lower personal tax burden than wages since they are eligible for a dividend tax credit (more on tax differences below).
In practice, paying dividends to a corporation’s shareholders is rather simple. Dividends are issued, and money is moved from the corporate account to the personal account of a shareholder in one or more transactions. Each year, the corporation must produce and file T5s for all dividend-paying shareholders.
Dividends are complicated since they are given and paid based on share ownership. For example, if Pied Piper Ltd. intends to pay $100,000 in dividends to Class A common stockholders, it must do so based on ownership percentage. Dinesh would receive $30,000 and Richard would receive $70,000 if Dinesh owns 30% of Pied Piper’s class A shares and Richard owns the remaining 70%. If numerous shareholders own the same class of shares, this can make allocating various amounts of revenue to them problematic.
WHY CHOOSE DIVIDENDS
Dividends can be a convenient way for business owners to get money out of their company. The following are a few important benefits:
- Dividends eliminate the need to contribute to the CPP, lowering both business and individuals expenditures. The disadvantage is that you are unable to contribute to the Canada Pension Plan. More money now, less money tomorrow.
- Simplicity – If you control 100% of your firm, you may simply declare a dividend and have money sent from the company to your personal account. There’s no need to sign up for payroll or send in source deductions.
- Payroll Penalties are less likely – Payroll remittances remain constant. They are usually due every month, with heavy penalties for late payments. The possibility of late or missed payroll remittances is eliminated when dividends are paid. However, when it comes to distributing dividends, T5s must be filed on time once a year.
DIVIDEND RESOLUTIONS
If you pay dividends, you’ll need to file T5s and produce dividend resolutions, which are corporate documents.
Check out Ownr for a sleek method to organize your business documents like dividend resolutions.
You can save 20% on their managed corporate plans if you use our affiliate link.
Ownr is a useful tool for keeping your business records organized without having to pay a lawyer’s expensive fees.
Which Method Creates Less Tax?
So, the most typical question we get concerning salary vs. dividends is, “Which strategy will save me money on taxes?” This is an essential question, but changes to regulations that went into force at the beginning of 2018 have made it more difficult to save money by using one of the two methods.
I’ve put this question last because I believe it’s more necessary to understand and examine the factors outlined above before comparing various pay and dividend models for tax savings. There’s a reason why the results of computations often reveal just minor tax savings in one direction or another.
INTEGRATION
Integration is a tax notion that law is attempting to achieve. When comparing dividend payments with wage payments of the same amount, the aim is that there should be little to no difference in overall income tax paid (personal tax + company tax). This is how it works:
- Dividends do not lower corporation taxes, but they do lower personal taxes.
DIVIDEND SPRINKLING
Dividend sprinkling was a method used in the past by business shareholders to avoid the issue of integration and shift the balances of tax savings in their favor. This was accomplished by deferring dividend payments to a spouse or adult family member with a lower income. The spouse or adult family member would pay less personal tax on their dividend income because they are in a lower tax category than the business owner.
Now that dividend sprinkling is more difficult to accomplish, it’s much more crucial to think about the qualitative considerations described earlier when determining which type of distribution to utilize.
In this essay regarding Tax on Split Income, we go over the limitations of dividend sprinkling (TOSI).
CALCULATING AND COMPARING TAXES
Although there may not be as much tax savings as there once were, we can still do some simple calculations to evaluate if dividends or wages are the more tax efficient option.
The idea is to compare the total taxes paid (corporate + personal) if dividends were used to the total taxes paid if wages were utilized. You can estimate personal taxes using a program like the SimpleTax Calculator, and you’ll need your business tax rate to estimate corporate taxes. Alternatively, if that sounds like too much trouble, you may contact your accountant, who can gladly run some numbers for you (we love that stuff).
Common Scenarios
Finally, let’s take a look at a few frequent circumstances we see and explain what you should do as a business owner in each of them.
- If you struggle with administrative tasks, such as making payments on time, it may be easier and less expensive to pay yourself with dividends. Wages necessitate the timely and regular payment of source deductions. Penalties can quickly mount if source deduction payments are lost or late.
- Qualifying for Financing – If you plan to buy a house soon and know you’ll need to qualify for a mortgage, it would be a good idea to pay yourself as an employee (wages / salary). Banks prefer consistent income over erratic dividend payouts.
- Having Children / Parental Leave – If you are planning to have children soon and would like to collect Maternity or Parental Benefits, it may be more beneficial to work and earn money. Because withholding and remitting employment insurance premiums allows an employee to get maternity or parental benefits, this is a good idea.
- Paying Bonuses – Paying salaries in the form of a bonus to business owners can sometimes reduce or defer tax. Although this method is sophisticated and not relevant in every situation, it is crucial to know that it exists.
- Working Income Tax Benefit (WITB) – The working income tax benefit (WITB) is a refundable tax credit that provides tax assistance to low-income working people and families. Paying yourself a tiny compensation from your business may be advantageous in triggering this tax credit on your personal taxes. If you have a low personal or family net income for the year, think about it.
Learn More
- What about a holding company? In Canada, we’ve written about what a holding corporation is used for.
- Are you yet to be incorporated? Check out our article on whether you should incorporate or start the process through Ownr to learn more (our affiliate link provides 20 percent off the cost of incorporation).
- If you like this post, why not have a look at some of our other free resources or watch some of our YouTube videos?
Can an S Corp owner take a draw?
All S corp owners, also known as shareholders, who are actively involved in the firm must get a W-2 salary, according to the IRS.
As the business owner, you have the right to receive money from the company as a shareholder distribution. Distributions, on the other hand, cannot be utilized to replace an acceptable salary.
Owner Employee vs. Owner Nonemployee
Only if you are actively involved in running the business as a S corp owner do you need to pay yourself as an employee.
If you work for your company, you’ll get a fixed W-2 wage and have your income tax, Medicare tax, and Social Security tax withheld automatically.
Owner salaries, as well as half of the FICA tax spent on them, are tax deductible, lowering the business’s taxable income.
Some business owners contribute only a small amount to the company’s operations. If you’re not actively involved in your company’s day-to-day operations, you may qualify as a nonemployee, which means you don’t get paid.
You can still take an owner’s draw as a non-employee owner. Non-employee compensation, on the other hand, will be reported on Form 1099-NEC.
Calculating Your Salary
You may not have enough revenue to compensate yourself for the first year or two after starting a small business or startup.
However, if your company is debt-free and has a consistent cash stream, you must budget for your pay.
To prevent any IRS concerns, the IRS advises S corp owners to provide themselves adequate compensation (i.e. giving yourself a lower salary so you can pay less taxes could put you in hot water).
Reasonable compensation entails paying you a wage that is comparable to what you would pay another employee with similar responsibilities. You should also ensure that you pay yourself enough to meet your own costs.
If you’re the CEO, for example, you shouldn’t pay yourself the same income as an executive assistant or office manager, as this could cause the IRS to look into your compensation structure.
When determining a fair compensation for your position, consider numerous criteria such as your amount of experience and duties. You could also compare salaries for similar jobs to make sure you’re on level with industry norms.
To access up-to-date compensation data, we recommend using PayScale or the Bureau of Labor Statistics.
You should take care of some bookkeeping essentials before calculating your salary. Calculate how much of your revenue should be set aside for business taxes using your balance sheet. When doing so, it’s preferable to seek advice from a certified public accountant (CPA) or a tax counselor.
Salary vs. Shareholder Distributions
S corporations, unlike C corporations, do not normally make general dividend distributions. Instead, S corporation owners can take money out of the company through shareholder distributions.
A shareholder distribution is a payout made from the S corporation’s profits that is taxed at the individual level. In other words, shareholder distributions are not taxed on Social Security or Medicare and are not reported as personal income.
The IRS requires that shareholder distributions not be used to substitute a reasonable pay.
Taxing Remaining Profit in an S Corp
The salary of the owner of a S corporation is treated as a business expense, just like that of any other employee. Any net profit that isn’t used to pay owner salaries or put into a draw is taxed at the corporation tax rate, which is typically lower than the personal tax rate.
A sole proprietorship, on the other hand, reports and taxes all net profit as personal income on the owner’s tax return.
