Discussion:C-Corp. NOL and Dividends
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Discussion Forum Index --> Tax Questions --> C-Corp. NOL and Dividends
| 1 November 2006 | |
| I think I know the answer to this, but someone please confirm.
A C-Corp. client of mine has a 2005 NOL of about $500K. For 2006, he will most likely have profits of about $400K. He asked me today if, since he would not use the full NOL in 2006, he could just pay himself $100K in dividends instead of a salary, and thus fully use up the NOL. This way, he would be taxed at the 15% rate for dividends received. I told him that dividends of a C-Corp. come from the accumulated earnings and profits, and since he doesn't currently have any E&P/Retained Earnings (the NOL ate it up), he has no pool from which to pay dividends. Is my line of thinking correct on this? | |
Michaelstar (talk|edits) said: | 1 November 2006 |
| I agree with your conclusion. Dividends can only be paid out of current and past earnings. Also, if this individual is a working employee of the corporation - he needs to pay himself a reasonable salary before he can pay himself dividends or the IRS would have strong grounds to claim he was avoiding payroll taxes and all that goes along with it. | |
| 1 November 2006 | |
| Earnings and profits are not the same as retained earnings. This corporation has $400,000 in current year E & P, and therefore, any amounts paid would carry out ordinary income to that extent. Amounts paid in excess of current or accumulated E & P will simply reduce his basis in the stock. | |
Michaelstar (talk|edits) said: | 1 November 2006 |
| Riley2 - I still do not believe that the client could pay themselves dividends and not a reasonable salary thus avoiding the payroll tax issue. If the t/p was to pay themselves dividends and report this on the 1099-DIV - then are you saying that the dividends would just not also be classified as qualified dividends which would allow the 15% rate? | |
| 1 November 2006 | |
| Man, don't we fit the true stereotype of accountants...answering tax research questions after the kids pass out from their Halloween sugar high! :)
Riley2: Your assertion is what cast the little bit of doubt into my mind. If he has $400K in current year E&P - would this "pool" qualify to pay dividends out of? What if the $500K NOL reduced his basis in the C corp stock to zero? What if retained earnings are actually negative? To clarify, the $400K profit assumes that he is going to pay himself his normal reasonable salary (which is about $200K, so it is definitely reasonable). So, given that he is not avoiding the payroll tax issue - would it then make it reasonable to pay himself $100K of qualified dividends, get a 15% rate, and use up his NOL in the process? | |
| 1 November 2006 | |
| Given the fact pattern, the money to pay the dividend has to come out of current earnings which is why it would be taxable. (Review form 5452 and watch what happens with the calculations). I don't see how the NOL is affected. Non-taxable dividends would reduce basis but negative retained earnings? This is a C not an S. | |
| 1 November 2006 | |
| I think the chief issue Mikelim is not grasping is that dividends do not affect income. They are strictly a balance sheet transaction between the Corp and S/H reducing cash and retained earnings. They never enter into the operations of a Corp and therefore cannot influence an NOL. | |
| November 1, 2006 | |
| No, I think the confusing part is that with a first year NOL, there are no R/E. And he's wondering how you can therefore pay dividends? The answer appears to be that it can come from current earnings, but I wonder about that. Suppose you're showing current earnings and pay dividends, but by year end, the profit turns into another loss? You've paid dividends when none were available. I'm not up on C corp distribution rules, so just talking out loud about what looks like a potential problem to me. | |
| 2 November 2006 | |
| Dividends definitely come out of current E&P first, then accumulated E&P. (See §316(a)(1) & (2) and the flush language after §316(a)(2) for ordering). To the extent of E&P the distribution is a dividend (§301(c)(1). To the extent E&P is exceeded, the distribution reduces basis as Riley2 explains above. (See §301(c)(2).) After basis in the stock is exhausted (i.e., goes to zero) the distribution results in capital gain. (See §301(c)(3).)
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| 2 November 2006 | |
| PGatto - very nicely clarified. That basically confirms that, if indeed he does show a profit for 2006, he can pay dividends out of current year E&P, measured at the end of the year (just as long as the dividends paid do not exceed current E&P).
JR1 - I must not have been very clear. 2005 is not his first year, the NOL for that year just happened to reduce his R/E to a negative balance. I was just wondering about the feasibility of substituting a dividend instead of some salary when he chose to compensate himself for this year. In prior years, he would pay himself a salary of about $200K, but if he was showing a profit this year, perhaps he could pay himself $100K in salary and $100K in dividends. Then he could take advantage of the 15% tax rate on those dividends, instead of his effective tax rate (which is much higher). Then his net income would be $500K instead of $400K, since the $100K in dividends are not an expense, but a balance sheet item. (so they would not reduce net income like taking an additional $100K in salary would do). Does this make more sense? | |
| November 2, 2006 | |
| Do document the reasoning behind the salary cut in the minutes...decreasing proitability, etc. Otherwise, they know what you're doing. | |
