Updated October 30, 2020:

C Corp Dividend Tax Rate

The C corp dividend tax rate is a major reason why many small business owners consider instead forming their company as an S corporation.

C corporations are taxed both at the initial corporate level and then when proceeds are distributed to its owners. In contrast, S corporations are only taxed at the individual level as the

S corporation's profits and losses pass through to the owners. However, S corporations don't always result in lower tax liability, as it varies depending on the specific corporate and individual tax rates.

The cheapest way for C corporations to distribute profits to their owners and lower their tax liability remains through dividends.

Dividends do not have many tax benefits, as while the dividend is taxed on the recipient, the corporation is not able to deduct the dividend's cost.

There are two types of corporations that many business owners consider with very different tax structures.

The first major corporate form is C corporations. C corporations are the standard corporate business model. The C corporation is a distinct legal entity and will pay taxes as an entity.

An S corporation is an alternate type of corporate entity subject to a variety of strict qualifications and criteria. The S corporation is generally intended for small businesses, due to restrictions in shareholder number and type.

The S corporation passes through most of its income and losses to its owners, who report the revenues on their personal tax returns. The S corporation has very limited tax liability on a corporate basis.

C corporations have ways of significantly reducing their tax liability that may make them more attractive than S corporations under certain circumstances. C corporations can reduce their taxable income through the use of salaries as well as reinvesting profits in the business.

One major benefit of corporations is that they can be easily transferred or have ownership structures in ways that are more flexible than many other types of business models.

C Corporation Compensation and Dividends

C corporations have two main ways of distributing their earnings. The first is by paying employees, of which you or other owners may be a part. The other major way is by distributing a dividend to all of the corporation's owners in proportion to their ownership.

The tax comparison is complex, as employees will be subject to various taxes including business payroll taxes and individual payroll taxes. Dividends do not have any payroll taxes, and the rate varies depending on current tax law governing dividends.

C corporations are their own business and have their own tax issues to determine. Whether the C corporation pays its earnings as salary, dividends, or keeps the earnings will have also a tax impact on the business itself.

The C corporation will be permitted to deduct any salary they pay. Given that corporations face a significant tax rate on their own, any salary paid through this method will proportionally reduce that tax liability by that rate.

Corporations won't be able to deduct dividends, however. The dividends, therefore, have a little tax benefit for the corporation as an entity, even if they may have for the individuals receiving the dividend.

If you are a major owner of a small C corporation, it may be more worthwhile from a tax perspective to pay yourself as an employee rather than through dividends, as your overall combined corporate and individual tax liability may be lower. Here are current relevant tax rates as of 2018:

• Corporate Tax Rate: 21 percent

• Single ($500,000+), Married ($600,000+): 37 percent

• Single ($200,000+), Married ($400,000+): 35 percent

• Single ($157,500+), Married ($315,000): 32 percent

• Qualified Dividends (10-15 percent individual rate): 0 percent

• Qualified Dividends (25 percent to 35 percent individual rate): 15 percent

• Qualified Dividends (37 percent individual rate): 20 percent

Usually, the employee-compensation structure will result in lower tax liability than through dividend payments.

IRS Regulation on C Corporation Dividend Rate

The IRS allows corporations to deduct salaries they pay to employees, up to a "reasonable" degree.

Whether compensation is deductible relies on whether it is truly compensation for, and proportional compensation to market levels, services rendered.

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