The way you structure your assets and handle your cash flows can have a direct impact on what you pay in taxes. If you operate as a C corporation, an effective way to distribute money from your company without incurring additional payroll taxes is to lease your property to the company. The company would pay rent to the shareholder for use of the property. In turn, the shareholder will include rental income on their personal return and the company would take a deduction for the rent paid. The rental payments reported by the shareholder would not incur payroll taxes nor would they be subject to the double tax on dividend distributions from a C corporation.
When does it make sense to use this approach?
If your company operates as a C corporation and you own real estate or personal property that can be used by the business, it would be a good approach with some caveats. You would need to be sure there was a valid business purpose and work with a tax professional or business adviser to ensure that the proper business titling and leases are in place. You would also need to use a market value annual rent amount.
Tax Benefits by Avoiding Double Taxation of Dividends
Corporate earnings are taxed first as income to the C corporation, then taxed again as dividends when the shareholder reports the distribution on his individual tax return. Dividends received by an individual shareholder from C corporations are currently taxed at long-term capital gains tax rates. If the shareholder receives rental income rather than dividend distributions, the company can take a deduction for the rental expenses. The rent payments are only taxed as income to the shareholder on their personal return.
John owns a C corporation that intends to distribute $85,000 of revenue as dividends to him. The company would pay tax on that $85,000 based on the corporate income tax rate of 35%. The net amount available for John to receive as a dividend after the corporate tax would be $55,250. When John receives the $55,250, he reports the income as dividends on his personal return. Assuming John is in the highest tax bracket, the dividends are taxed at a capital gains rate of 20%, which would net John $44,200 from the original $85,000 of revenue.
Frank owns a C corporation as well, but he also owns a building that he is able to rent to his company. In the same scenario, let’s assume that the company pays $85,000 in annual rent versus distributing a dividend. Instead of the company being taxed the 35% on the $85,000, the company takes a deduction for the rental payments. The full $85,000 is paid to Frank as the landlord. Frank would claim the $85,000 on his personal tax return as rental income at an ordinary income at a tax rate of 39.6% (assuming the highest tax bracket). Frank would receive $51,340 net of taxes from the original $85,000 of revenue, $7,140 more than John.
Shift Income Tax to Lower Bracket
Another approach could be to gift property to your children, spouse, or other family members who are in a lower tax bracket. You would rent the property back from them, which would shift the income to them on their personal return. You would be reducing the overall tax for the family if they are in a lower tax bracket. This would be good for tax planning purposes as well as helping to lower the overall estate for an individual who has an estate valued more than the lifetime exclusion. There are limitations and other things to consider with this strategy, so you should work closely with an adviser when structuring this transaction.
William G. Lako, Jr., CFP®
Shawna L. Theriault, CFP®, C.P.A.
William G. Lako, Jr., CFP®, serves as a principal at Henssler Financial. Shawna L. Theriault, CFP®, C.P.A. is a Managing Associate at Henssler Financial, specializing in assisting high net worth individuals, families and businesses in tax, financial and estate planning. Both Lako and Theriault are CERTIFIED FINANCIAL PLANNER™ professionals.
Founded in 1987 by Gene W. Henssler, Ph.D., Henssler Financial provides solutions for individual, corporate and institutional clients that incorporate a range of services, including wealth management, financial planning, tax preparation and consulting, small-business retirement planning and estate planning. www.henssler.com