In this episode of Coffee with Carl, attorney Carl Zoellner explains:
When does it make sense to take a salary from your C-corporation, from a business planning perspective?
Updated September 16, 2020
In the most recent episode of Coffee with Carl, I explained the dreaded “double taxation” issue that affects salaries taken from C-corporations. In that episode, I hinted that there are some times when you want to face the issue of double taxation and take a salary from your C-corporation anyway. Let’s break down when it makes sense to take a salary from your C-corporation even with the issue of double taxation.
Firstly, keep in mind one of the benefits of taking a salary is that it’s tax-deductible to your C-corporation. Then, you’ll pay income tax at your individual tax bracket plus self-employment tax. Yes, this is the much-talked-about issue of “double taxation” since your C-corp will have already paid a flat tax of 21% on its profits. Thus, when you then pay taxes on your salary, you’re being taxed twice.
When would it make sense to do this? If you’re trying to qualify for better loans and/or interest rates.
For real estate investors, being lendable is crucial. In order to get the loan or interest rate you’re after, you must show W-2 income. This means taking a salary from your C-corporation. If you don’t have any W-2 income because you haven’t taken a salary from your C-corporation, you’ll be hard-pressed to find lenders willing to offer the best loans or rates.
Note that there is a difference here between C- and S-corporations. The loan process is usually easier if you pay yourself a W-2 salary out of your C-corporation versus an S-corporation. This is because, with a salary from a C-corporation, the lender will only see your W-2 and not dive into your corporation. With an S-corporation, they may see a reasonable salary you’re taking from your S-corp, but you may run into issues when the lender sees the K-1. Seeing the K-1 usually results in the lender wanting to dive into your business to verify its overall health. And oftentimes, when you’re just getting started, your business may not look that appealing to a lender.
In this regard, we can control what the lender sees by taking a salary from the C-corp. This strategy is most advisable when attempting to fit into a lender’s specifications. It’s important to run the numbers and calculate the taxes owed on the salary you’d take versus the difference in loan value or interest rate with and without the salary. It may be worth paying additional tax on the salary upfront if it allows you to qualify for a larger loan at a better rate.
This concept falls under the “business planning” leg of the three-legged stool we often discuss at Anderson Advisors. When it comes to running a business, there are three critical aspects that must be considered, like a three-legged stool: asset protection, tax planning, and business planning. If you focus only on one or two areas and not all three, you’ll likely encounter headaches down the road.
Watch as Carl breaks down when it’s useful to take a salary from your C-corporation to appear more lendable.
As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, another great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets. One of my favorites as well is our Infinity Investing Workshop.
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