Navigating Corporate Advances: Implications for S Corps and C Corps

Understanding the nature of corporate advances is crucial in the realm of corporate finance. Drenen Financial Services brings clarity to a common question: Are corporate advances to the owner loans, dividends, or salaries? This article extends its exploration by distinguishing the implications in S Corporations (S Corps) and C Corporations (C Corps).

Case Study: XYZ Corporation

Consider XYZ Corporation, receiving a large sum from the company. The classification of this transaction depends on whether XYZ is an S Corp or a C Corp.

Loans vs. Dividends vs. Salary

• Loans: Formalized with a promissory note, they require interest payments and a repayment schedule, regardless of the corporation type.
• Dividends: While S Corps distribute non-taxable dividends from after-tax profits, C Corps’ dividends are taxed twice: at the corporate level and then at the shareholder level.
• Salaries: Salary to owners must be reasonable. In S Corps, salaries are subject to employment tax, but dividends are not. C Corps may prefer higher salaries to lower the taxable income at the higher corporate tax rate.

S Corps vs. C Corps: Key Differences

S Corps:

• Profits and losses can pass through to your personal tax return.
• Dividends are often not subject to self-employment tax.
• Salary must be reasonable to avoid reclassification by the IRS.

C Corps:

• Subject to double taxation on dividends.
• Can retain and reinvest profits within the company.
• Higher salaries can reduce corporate taxable income but are subject to higher individual income tax rates.

IRS Audit: Key Questions for Corporate Advances

During an IRS audit, several questions help ascertain the nature of advances:

1. Is there a written obligation for repayment?
2. Are interest payments outlined?
3. Is there a fixed schedule for repayment?
4. Was the borrower’s creditworthiness considered?
5. Are repayments being made as scheduled?

Your Financial Navigator: Drenen Financial Services

At Drenen Financial Services, we excel in demystifying the complexities of corporate finance, whether you’re an S Corp or a C Corp. With our expertise, we guide you in ensuring compliance and optimal financial structuring. Reach out to us at (413-569-0015) or via email (office@drenenfs.com) for tailored advice and solutions.