• LinkedIn
  • YouTube
  • Twitter
  • Facebook
  • Google+

Pay out dividends, pocket tax difference

Get PDF file

by on
in Small Business Tax,Small Business Tax Deduction Strategies

Crazy as it seems, you may fare better in 2015 if your corporation forgoes a deduction for certain amounts.

Strategy: Make this a “dividend year.” In other words, instead of receiving income in the form of tax-deductible wages, arrange to have the company pay out dividends to yourself.

If you’re in a high tax bracket and your company is in a relatively low one, which is often the case, you’ll save tax overall because of the tax break for qualified dividends.

What’s more, under President Obama’s budget proposals for 2016, qualified dividends could be taxed at a higher rate. So this may be the opportune time to utilize this tax strategy.

Here’s the whole story: Under the “Bush tax cuts,” dividends received by most folks in 2015 from domestic companies are taxed at a federal rate of 15%. However, if you’re in the top 39.6% ordinary income tax bracket, your maximum tax rate for qualified dividends is 20%. (President Obama has proposed a 28% top rate for qualified dividends.) In contrast, wages are taxable at ordinary income rates reaching as high as 39.6%.

Although wages are deductible by a C corporation and dividends are not, a business owner may benefit by shifting wages to dividends if he or she is in a high tax bracket in 2015. In addition to the tax break for dividends, you avoid payroll taxes on amounts paid out as dividends.

Example: You’re in the 35% tax bracket and receive an annual $100,000 salary from your company. The company is in the 25% bracket. If it pays an extra $10,000 to you in dividends instead of as a year-end bonus, your income tax on that amount is $1,500 (15% of $10,000) as opposed to $3,500 if the $10,000 is paid as a bonus (35% of $10,000), or $2,000 less in tax. Also, with the dividend strategy you would save $765 in payroll tax (7.65% of $10,000), while the company would save the same $765 for its share of the payroll tax responsibility. Total savings: $3,530 ($2,000 + $765 + $765).

Even though your company loses a $2,500 deduction (25% of $10,000), you and the company combined still come out $1,030 ahead ($3,530 – $2,500).

Tip: This strategy doesn’t work for personal service corporations because they are required to pay federal income tax at a flat 35% rate. 

Leave a Comment