Are dividends considered part of a company’s profit? I’m not an accountant, so please go easy on me!
My accountant mentioned that salaries are treated as expenses, while dividends are categorized as profit. So, I’m wondering—would I be taxed on the profit I withdraw from my business (after expenses) in addition to my personal taxes? This feels a bit confusing, especially since I’m a small business and usually take most of my profits to pay myself. Would I end up paying less in taxes if I paid myself as an employee instead?
One response
Great question! It’s definitely a bit of a complex area, but I’ll try to break it down simply.
Dividends vs. Salary: Dividends are a distribution of a company’s profits to its shareholders, while a salary is an expense the company incurs for work performed. As you noted, salaries reduce the taxable income of the company, while dividends do not. This means that, at the corporate level, paying salaries can lower the company’s tax liability.
Taxation: When you pay yourself a salary, the company deducts that amount as an expense, which reduces its taxable income. You, as an individual, will then pay personal income taxes on the salary you receive. Dividends, on the other hand, are taxed differently. Generally, they can be subject to double taxation—once at the corporate level and again on the individual level when you receive them.
Overall Tax Implications: If you are taking all your profits out as dividends, you might indeed be facing higher overall taxes compared to the scenario where you pay yourself a salary. The double taxation on dividends can increase your tax burden.
Considerations: It’s important to consider your specific situation, including how much you can pay yourself without running into issues with the IRS regarding reasonable compensation, and how it affects your overall tax strategy. Additionally, other factors like your company’s revenue, your individual tax bracket, and potential future earnings should be considered.
In many cases, especially for small businesses, a combination of salary and dividends can optimize tax liability. It’s always best to consult your accountant about your specific situation, as they can provide personalized advice based on your financials and goals.
Hope that helps clear things up!