“ Am I subject to income tax on the Retained Earnings?”---->For smaller companies ,reported profits result in retained earnings, a type of equity. As years roll by, these accumulated after-tax earnings increase the retained earnings account, unless they are distributed.So,r/e in a C corporation will eventually be taxed again, either as dividends, salary, bonuses or as liquidating dividends when the corporation is terminated. Of these four choices, the most favorable is a distribution of salary and bonuses, which are deductible as compensation at the corporate level, although they are subject to additional employment taxes, FICA tax. Dividends are not deductible at the corporate level and are often frowned upon in smaller entities for their lack of deductibility.
“What can I do to minimize a tax hit?”---> Many small to medium corporations zero out their earnings to claim salaries and bonuses, plus other deductions, that significantly reduce the annual profit ,retained earnings of the corporation. As long as a C corp unnecessarily accumulates r/e, there is a special, somewhat punitive, tax called the Accumulated Earnings Tax which imposes a special tax on the corporation if it has what are deemed to be excessive earnings. This tax can be avoided by distributions of earnings in the form of dividends, or, within reason, as bonuses by following the method suggested above of documenting bonuses to officers. R/E in excess of $250,000 should be justified.Another way of justifying accumulated earnings is to show through corporate minutes that there is a future need for such retained earnings(As long as you are looking to expand or grow this year or next, If so, there are programs like Section 179 or 100 % bonus depre ruel) even programs in the stimulus act that could help your business grow and reduce its taxable income through deductions and credits might be another way of thinking forward benefiting your business in the future and reducing your tax burden today.; for example, building a new factory, introducing a new product line, or having a cash reserve for an expected business downturn.If you area sole owner of the C corp, then it does not make sense to pay yourself salary from r/e or putting it into a deferred comp plan. Your corporation has already paid income taxes on those earnings. Paying income taxes twice is really the worst thing you could do. Dividend tax rates are going up in 2011 so giving up 15%(as long as yur marginal tax rate is 25% or higher) is not a bad option. If your corporation has been around for 5 years you can convert to an S. Whether you should or not, or come up with an alternative plan is more complex, BuiltInGain tax situation, I mean.