Consider Taking Dividends Now
Oct 05, 2010
Many farmers created corporations several years ago that have always been taxed as a regular C corporation or may have switched to an S corporation after several years of profitable operations. These corporations may have several hundred thousand dollars of retained earnings that under current law if they were distributed to the owners would be taxed at a top federal rate of 15% and if the farmer was in the 15% tax bracket on its other taxable income, it would be taxed at zero.
With the current turmoil in the election, it is hard to know if these favorable rates will hold next year. Therefore, you should carefully review your tax situation with your advisor and determine if you should distribute these retained earnings to take advantage of the low rates. One negative is that most states will tax these dividends at regular rates, so the actual combined tax rate on dividends for this year can exceed 25%.
Some farmers are concerned that if the money is distributed to them, the corporation will not have enough liquid assets to operate. There are many ways to reduce or eliminate this problem. The shareholder can loan the money back to the corporation at very favorable rates. This allows the farmer to earn better than what they can get on a money market fund or CD (these rates right now are usually less than 1%). Also, the corporation will generally pay a better rate than they can get at a bank. The farmer can also contribute the money back to the corporation as additional paid in capital which has no tax consequences.
If the Bush Tax Cuts do expire on January 1, 2011, then your maximum tax rate on dividends will go from 15% of almost 40%, therefore, this year presents a great opportunity to lock in the lower rates with out any risk.
With year-end coming up, I will most likely continue to write posts regarding this situations and other related to it.