Thursday, June 27, 2019
Bob Kilpatrick (Northern Arizona) & Dennis R. Lassila (Texas A&M), Compensation vs. Qualified Dividends for Shareholder-Employees After the TCJA, J. Tax'n, Vol. 129, No. 1, pp. 6-13, July 2018:
One important question facing shareholder-employees of small, closely-held C corporations is how to pay themselves for working in and/or running their corporations. Traditionally, C corporation shareholder-employees have been advised to pay themselves compensation instead of dividends, because compensation is generally deductible by the corporation, whereas dividends are not. The payment of compensation has been viewed as one way to mitigate the double taxation of C corporation net income. The combined amount of individual and corporate income taxes and employment taxes if the payment is in the form of compensation was typically smaller than if the payment were made in the form of qualified dividends. Thus, there has been a tendency for corporations to pay compensation rather than dividends to shareholder-employees.
The Tax Cuts and Jobs Act of 2017 (TCJA) has changed all that beginning in 2018. The reduction in the marginal tax rate for C corporations to 21 percent (down from 35 percent), the reduction in individual tax rates, and the retention of special low tax rates on qualified dividends substantially reduce the combined amount of taxes on qualified dividends relative to that on the same amount of compensation. We found that the combined amount of taxes on qualified dividends is less than that on compensation in many instances, especially when the amount of the payment to the shareholder-employee is $150,000 or less. This finding is significant because most small business owners take a yearly salary of less than $100,000.