Avoiding double taxation on cash you withdraw from your corporation requires that you use approved methods.

For owners of an incorporated business, a perennial question – one that never yields the desired answer – is "How can I take money out of my corporation?"

In a simple world, a major shareholder could simply treat his closely held corporation as his alter-ego, using corporate assets as personal assets and transferring them back and forth as he sees fit. Unfortunately, a corporation is a legal, taxpaying entity separate from its owners, and the use of corporate assets must have a business purpose that benefits the corporation.

Thus, individuals who control cash-rich corporations cannot indiscriminately write corporate checks to themselves without, at best, incurring costly tax consequences and, at worst, putting at risk the protections that they hoped to gain by incorporating. Controlling shareholders must follow any of a handful of approved methods of pulling cash or its equivalent from their corporations.

Dividends. The simplest way to withdraw cash from your corporation is to use a dividend distribution. Unfortunately, "simplest" doesn’t equal "best," since a dividend distribution carries with it the problem of double taxation.

Preferable alternatives. Several more appealing methods of taking cash out of your corporation are available to you.

Compensation. Put yourself on the payroll. Your compensation isn’t subject to double taxation, provided it’s reasonable in relation to the services you render. If your compensation is excessive – e.g., if you pay yourself $150,000 for menial, part-time work – the portion that the IRS finds excessive will be treated as a dividend.

Rental. Payments that your corporation makes to you for the use of your assets, such as the rental of real estate or personal property, are another option. Again, those payments must reflect what the market will bear. Excessive rental payments will also be treated as dividends.

Loan repayment. If you’ve loaned money to the corporation, let it pay you back. To avoid tax problems, the debt must have been properly documented and contain terms that affirm that it is truly a debt, not equity. Also, the corporation must not have an unduly high debt-to-equity ratio.

Borrowing. You may also withdraw cash by borrowing money from the corporation. Be sure that (a) the loan is properly documented, (b) the documentation includes a repayment schedule or due date and (c) you repay the loan by the dates due. In addition, the loan must bear interest at a rate not less than the current applicable federal rate. If the corporation charges you interest at a lower rate, the interest income it foregoes will be treated as a dividend or as compensation to you.

Fringe benefits. You may achieve the equivalent of cash withdrawals by receiving certain fringe benefits that are deductible to the corporation and not taxable to you. Benefits may include life insurance, certain medical benefits, disability insurance, dependent care, etc. Most of those benefits are tax-free only if they are provided in a nondiscriminatory fashion, i.e., they are also available to all other employees. You can also establish a salary reduction or cafeteria plan that would allow you and other participating employees to take a portion of compensation as nontaxable benefits, rather than as taxable compensation.

Business-related expenses. Your corporation should also pay all of your allowable business-related expenses, such as subscriptions, certain dues, auto expenses, etc.

Sale of assets. You may withdraw cash by selling to the corporation property that you own. Again, such transactions are subject to limitations:

• First, you should not sell property at a loss to a corporation in which you own 50% or more of the stock, since the loss on the sale will be disallowed.
• Also, you should think twice before selling depreciable property at a gain to a 50%-owned corporation, since the gain will be treated as ordinary income rather than capital gain.