Owners and operators of C-corporations can have effective diversification of compensation planning by utilizing a deferred owner compensation plan. Deferring owner compensation amounts simply to this: “reasonable” payments in owner compensation are fully tax deductible from the C-corp giving them the ability to avoid the standard double tax. When the good times roll in and the company becomes profitable many business owners wish they could pay themselves above and beyond what would be considered “reasonable” by the IRS. Unfortunately by the time the profits begin to pour in, the time has passed for deferring compensation and the double tax is due.
Plan Ahead in the Lean Years
C-corporation owners, especially those who operate services or time-intensive “toiler” businesses, generally experience a dearth in the early years when the business is young. During this time, the owners often take a discounted, meager or non-existent salary. Planning ahead during times of lean, helps to shield against taxes when profitability improves.
Entrepreneurs can plan ahead by setting compensation levels above what the business can afford to pay, thus “kicking the compensation can down the road” a few more years. The accruals of owner compensation can then kick-in when profit improves. Thus, when the business is kicking out a steady cash flow, the entrepreneurs are able to be paid a regular salary as well as receive the accrued, but unpaid salaries from previous years.
Reducing Reasonable Compensation Risk and Corporate Tax
Avoiding tax when selling your business is part of what we do. And unless you plan on converting from an C-Corp to a S-corp (which can be arduous), there are always double taxation issues with which owners will need to deal. Your business sale represents a huge liquidity inflow and probably your most taxable event ever. By siphoning cash out of the business in a prudent way prior to the business sale, owners can save on taxes before and after the liquidity event hits. In fact, this is an excellent way to avoid keeping too much in retained earnings or taking money out of the company regularly for double taxation hits. When the company finally does sell, it means the cash being kicked out in previous years isn’t either left in the business providing no benefit or is not double taxed as it is taken out when times are good and the IRS doesn’t wish to go after you for reasonable compensation issues.