Get ready, the big day is fast approaching – that is January 1, 2011. Unless Congress takes action, the passing of 2010 will mark the end of the so called Bush Tax Cuts. According to the Tax Foundation, those tax cuts have been worth about $2,200 in tax savings each year for the median family of four. While significant, it pales in comparison to the opportunity potentially missed by small business owners.
For years I have encouraged business owners to consider paying out prior accumulated earnings. And for years the answer has been, “Tell me before the law changes”. Listen up – I AM TELLING YOU BEFORE THE OPPORTUNITY GETS AWAY! – Let’s get specific.
For now, taxpayers in the lowest two tax brackets (10% and 15%) pay an unbeatable tax rate of 0% on long-term capital gains. Everyone else pays a maximum 15% rate on long-term capital gains. Now here lies the opportunity. Qualifying dividends are currently taxed like long-term capital gains. Typically dividends paid from your C-Corp or if elected from your S-Corp (If the S-Corp has retained earnings during a time when it was a C-corp) are qualifying dividends.
If Congress allows the tax cuts to expire, the cost of getting those retained earnings out of your company will skyrocket. Beginning on January 1, 2011, dividends will no longer receive the favorable capital gain tax treatment currently enjoyed. Rather, dividends will be subject to regular income tax rates. The news gets worse. Regular tax rates are scheduled to rise; the maximum rate being 39.6%.
In summary, C-Corp dividends paid through 12/31/2010 are taxed at a maximum rate of 15%. After 12/31/2010 they are subject to a maximum rate of 39.6%. Assume you have $75,000 of C-Corp earnings and you wish to get those earnings out of your business. If you are in the highest tax bracket, beginning on January 1, 2010 it will cost you $29,700 in federal taxes to distribute those earnings in the form of dividends or pay them out in the form of a bonus. Prior to 2011, those same retained profits could be distributed and only cost you$11,250 in Federal taxes!
Although it might appear that all corporate business owners should pay out old retained earnings before 12/31/2010, this is NOT the case. There are too many variables to consider in each individual situation. What you should do is seek advice and run the numbers. For some business owners, this will be as good as it gets; for others it might turn out to be just a bad idea.