Maximizing Cash Flow and Minimizing Taxes: Strategies for C-Corporations to Use Funds Tax Efficiently
Proper cash flow and tax planning are essential for business owners and their enterprises. One often overlooked topic is how to use tax laws to the best advantage, especially for C-corporations. Unfortunately, C-corporations often carry a negative connotation due to their double taxation, which occurs when a shareholder takes a distribution for personal consumption. However, with proper tax planning, a dividend tax may not be required for the business and business owner to use C-corporation funds for business purposes.
At Guardian Tax Consultants, we have worked with hundreds of business owners and have seen how effective tax strategies can significantly reduce taxes, increase cash flow, and protect businesses from risk. We have strategic partnerships across the United States with attorneys, actuaries, insurance specialists, and strategic advisors who can help you and your business execute these strategies.
Understanding Accumulated Earnings
Before we look at ways to use funds from C-corporations tax efficiently, we need to address the topic of accumulated earnings. A business owner may not wish to distribute funds from the C-corp and may choose to keep them as accumulated earnings for business purposes. This is perfectly acceptable, but be aware that if you keep more than $250,000, you could be subject to the accumulated earnings tax. Don’t worry, though— as long as you document your rationale for accumulating earnings and ensure it is for reasonable business expenses, you are likely prepared with the documentation you need for an audit.
Reasonable business purposes for accumulating earnings include expanding operations, purchasing new equipment, launching new products, increasing working capital, or preparing for potential future liabilities or uncertainties. Proper documentation and clear justification for these purposes can help ensure compliance with IRS regulations.
Below are 10 common strategies that we see business owners use to manage C-corporation tax efficiently.
1. Deductible Business Expenses
C-corporations can pay shareholders who work for the corporation through salaries, bonuses, and other deductible business expenses. These payments are treated as business expenses, reducing the corporation’s taxable income. The shareholders then report these payments as income, but only at their individual tax rates.
Example: A shareholder-employee receives a $100,000 salary from the corporation. This salary is deductible for the corporation, reducing its taxable income by $100,000. The shareholder reports the salary as personal income.
2. Lending Funds for Business Purposes
The corporation lends money to operating companies or other business entities for business purposes. These loans can be revolving, fixed, with options to renew and extend the debt to manage the cash flow of the business. These loans generate interest income for the corporation, which can be deductible for the borrowing entity. Proper structuring ensures compliance with IRS rules to avoid it being treated as a disguised distribution.
Example: The corporation lends $500,000 to a subsidiary at a 5% interest rate. The subsidiary uses the loan for business operations and pays $25,000 annually in interest to the corporation. The interest is deductible for the subsidiary and taxable income for the corporation. The loan terms include options to renew and extend, providing flexibility in managing cash flow.
3. Fringe Benefits
The corporation provides shareholders with fringe benefits such as health insurance, retirement plan contributions, or use of a company car. These benefits are deductible for the corporation and are often not taxable to the employee-shareholders, depending on the benefit.
Example: A shareholder receives health insurance benefits worth $20,000. The corporation deducts the cost of the insurance, reducing taxable income. The shareholder receives the benefits tax-free.
4. Qualified Retirement Plans, Pensions, and Cash Balance Plans
The corporation contributes to qualified retirement plans, pensions, or cash balance plans for the benefit of the shareholders. These contributions are deductible for the corporation and tax-deferred for the shareholders until withdrawal.
Example: The corporation contributes $50,000 to a shareholder’s 401(k) plan. This contribution is deductible for the corporation, reducing taxable income. The shareholder defers taxes on the contribution until they withdraw funds during retirement.
5. Insurance Premiums (Split-Dollar Insurance)
The corporation uses split-dollar life insurance arrangements to pay for life insurance premiums on behalf of shareholders. The corporation pays the premiums, and the shareholders benefit from the policy, effectively transferring wealth out of the corporation.
Example: The corporation pays $30,000 in premiums for a life insurance policy on a shareholder. The premiums are structured as a loan or an advance, with the shareholder eventually repaying the corporation or the corporation recovering the premiums from the policy benefits.
6. Pay Down Debt
The corporation uses earnings to pay down debt. Debt can be transferred from other operating companies under Section 351 and 357(a). Additionally, debt can be owned by the C corporation with collateral held elsewhere under a hypothecation agreement.
Example: The corporation pays off $200,000 of debt that was transferred from a subsidiary. The debt transfer is structured under Section 351, and the repayment reduces the corporation’s liabilities without triggering dividend tax.
7. Special Purpose LLC
The corporation creates a Special Purpose LLC and uses a split-dollar life insurance arrangement to pay premiums on a policy benefiting a shareholder. This allows funds to be moved to the Special Purpose LLC, effectively transferring money out of the corporation.
Example: The corporation pays $40,000 in premiums for a life insurance policy held by an LLC, which benefits a shareholder. The LLC manages the policy, and the arrangement transfers significant funds out of the corporation.
8. Non-Qualified Deferred Compensation Plans
The corporation establishes non-qualified deferred compensation plans for shareholder-employees. These plans defer compensation until a future date, reducing current taxable income and providing tax-deferred benefits to the shareholders.
Example: The corporation defers $100,000 of a shareholder’s compensation until retirement. The deferred amount is not taxed until it is paid out, providing a tax deferral benefit.
9. S Corporation Conversion
The corporation files Form 2553 to elect S corporation status. This allows the corporation to pass income, losses, deductions, and credits through to shareholders, avoiding double taxation at the corporate level.
Example: The corporation with $1,000,000 in annual income converts to an S corporation. The income is passed through to shareholders, who report it on their personal tax returns, avoiding corporate tax.
10. Captive Insurance
The corporation establishes a captive insurance company for risk mitigation. This allows the corporation to pay premiums to the captive, which can be a subsidiary owned by the shareholders. The premiums are deductible, and the funds accumulated in the captive can be used for legitimate business risks, effectively transferring funds out of the main corporation.
Example: The corporation pays $150,000 in premiums to a captive insurance company it owns. The premiums are deductible, reducing taxable income, and the captive uses the funds to cover specific business risks.
Note: All of these listed strategies are for business purposes only and should not be used to avoid paying dividends in lieu of items that a shareholder will personally consume or use.
At Guardian Tax Consultants, we have strategic partnerships across the United States with attorneys, actuaries, insurance specialists, and strategic advisors that can help you and your business execute these strategies.
- McHenry Advisors for Cash balance Plan – https://www.mchenry-advisers.com
- CIC Services for Captive https://www.captivatingthinking.com
- Section 409A deferred comp https://www.mezrahconsulting.com
- Lion Street for experts in these topics – https://lionstreet.com
- Schechter Wealth for Split dollar- https://www.schechterwealth.com
- Special Purposes LLC – https://lionstreet.com
- Covenant Tax Advisors
- Pacific Life ( https://www.pacificlife.com);
- Penn Mutual (https://www.pennmutual.com)
- Lincoln Financial (https://www.lincolnfinancial.com);
- John Hancock (https://www.johnhancock.com)
IRS References:
IRS Publication 535 – Business Expenses:
IRS Section 7872 – Treatment of Loans with Below-Market Interest Rates:
IRS Publication 15-B – Employer’s Tax Guide to Fringe Benefits:
IRS Section 401 – Qualified Pension, Profit-Sharing, and Stock Bonus Plans:
IRS Notice 2002-8 – Split-Dollar Life Insurance Arrangements:
IRS Section 351 – Transfer to Corporation Controlled by Transferor:
IRS Section 409A – Deferred Compensation:
IRS Form 2553 – Election by a Small Business Corporation:
IRS Revenue Ruling 2002-89 – Captive Insurance:
Each of these methods can be used to move significant funds out of a C-corporation while mitigating or avoiding dividend tax. Consulting with a tax professional is crucial to ensure compliance and optimal structuring.
Disclaimer: This article is for educational purposes only and does not provide tax or legal advice. Please consult with your tax professional and financial advisors regarding the topics discussed in this blog. Information is believed to be accurate as of the date of this writing.
C-corporations, tax planning, cash flow, tax-efficient strategies, accumulated earnings, business expenses, fringe benefits, qualified retirement plans, deferred compensation, S corporation conversion, captive insurance
