Q: Are tax-deductible expenses for Subchapter C corporations mainly in the form of distributions? Or are there other methods of payment for owners?
A: Distributions take the form of dividends for a Subchapter C corporation, and they are not a tax-deductible expense. A Subchapter C corporation pays its own income taxes directly, so there is no need to pass cash to owners for that purpose. Dividends from a Subchapter C corporation represent a return on capital to the owners and not compensation or cash for personal income tax payments.
In addition, one rarely sees dividends issued in closely held Subchapter C corporations because all dividends are taxed at both the company and individual level (known as double taxation).
Instead, Subchapter C corporations pay salaries and bonuses directly to owners. For a Subchapter C corporation, as well as for a Subchapter S corporation, salaries and bonuses are tax-deductible. However, they are not tax-deductible for partnerships, LLCs, and sole proprietorships.
Because distributions to owners of a Subchapter S corporation are not taxable to the owner – provided they do not exceed the owner’s basis in the company – they represent a major source of owner compensation. Partner and owner compensation takes the form of distributions for partnerships, LLCs, and sole proprietorships because a) salaries are not tax-deductible expenses and b) distributions are not taxable to the partner or owner, again provided they do not exceed the individual’s basis in the business entity.
Course overview: Business Income Tax Returns