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Old 01-25-2012, 03:44 PM
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What to do with Retained Earnings?

I recently closed my C-Corp business (corporation still exists). It was a print shop and all the assets were sold for salvage as the business model was obsolete. I have some money left in the bank... but also am left with a huge retained earnings of twice the cash on hand. Am I subject to income tax on the Retained Earnings. What can I do to minimize a tax hit? Thanks in advance.

Cash on hand: $200,000
Retained Earn: $368,000
Paid In Cap : $35,000



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Old 01-26-2012, 05:19 AM
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“ 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.



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Old 01-26-2012, 12:40 PM
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Retained Earnings

Thanks for your reply.
As you can imagine, all of the Retained Earnings is "paper profits" accumulated over the years since we incorporated. The cash on hand is all the liquidity we have. We have paid all debts so have no liabilities. All share are owned personally by husband and wife.

If I read your response correctly, we would dividend out the cash to the two shareholders. I think this (double entry cash accounting) action reduces RE by the same amount. That still leaves a fairly large RE on the books. What to do then? Is the C corp or stockholders on the hook for additional taxes? The Corp already paid taxes on this money. or, must the Corp declare some sort of phantom dividend that it can never pay because there never was any cash to back up the RE?



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Old 01-26-2012, 01:39 PM
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“If I read your response correctly, we would dividend out the cash to the two shareholders. I think this (double entry cash accounting) action reduces RE by the same amount. That still leaves a fairly large RE on the books. What to do then? “---->Acc retained earnings tax is a imposed by the federal government upon companies with retained earnings deemed to be unreasonable and in excess of what is considered ordinary. 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 2013(After 2012, the long-term capital gains tax rate will be 20% or 10% for taxpayers in the 15% tax bracket). In my opinion,so giving up 15% for 2011 is not a bad option as 15% ‘d be lower than reg C corp tax rate. OR as you cn asee, many small C corporations avoid this double tax problem by simply paying out all their profits as salaries and bonuses.These amounts are tax deductible so the corporation ends up with no profits and doesn't have to pay any corporate income tax.The owners then have to pay income tax at individual rates on their salaries, much like any other business owner.To avoid paying dividends which are subject to double taxation, another strategy is to pay shareholders consulting fees. Of course, you have to make sure there is some genuine consulting. These consulting fees will, however, be subject to social security and Medicare taxes.
“Is the C corp or stockholders on the hook for additional taxes? “---->As described above.
“The Corp already paid taxes on this money.”---->Correct.
“ or, must the Corp declare some sort of phantom dividend that it can never pay because there never was any cash to back up the RE?”---> For taxes, you add the dividend to your cost of the stock you already own. But,, not sure,, I think you also owe the tax on the phantom dividend; phantom stock is essentially a cash bonus plan, although some plans pay out the benefits in the form of shares. Phantom stock can, but usually does not, pay dividends. When the payout is made, it is taxed as ordinary income to the EE and is deductible to the ER. I am NOT sure however, in general, phantom plans require the EE to become vested, either through seniority or meeting a performance target.



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