Small business owners typically have direct access to the company’s bank accounts and can withdraw money from the accounts at will. This can create a tax morass, because business owners have a legal responsibility to correctly account for disbursements of money from their companies for tax reporting purposes. If the business has been organized as a C corporation, the owners (called “shareholders”) must be particularly careful to properly handle withdrawals. The Internal Revenue Service scrutinizes the characterization of disbursements to shareholders to make sure that taxes are being paid on corporate income, especially in closely held companies where shareholders also run the business, There are four ways to legitimately withdraw money from a corporation: by disbursing it as salary, loans, dividends or repayment of capital or expenses.
Authorize a disbursement of money to shareholders. Call a meeting of the board of directors and determine what type of disbursement the company wants to make. A disbursement can be made as compensation for services rendered, as a loan to a shareholder, as a dividend or as repayment of a capital contribution or an expense. Always refer to the corporation's bylaws for any provisions or restrictions involved with authorizing these types of disbursements. Record the decision regarding the type of disbursement to be made in the meeting minutes. Memorialize the decision in a corporate resolution and file it with the corporate records.
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Set compensation levels if the disbursement decision concerns salary for shareholders who work for the company. Since salary payments are treated as corporate expenses and come out of corporate income before profit is calculated, the amount should be agreed upon by the board or a majority of the shareholders.
Draft a loan agreement if the disbursement will be classified as a loan to a shareholder. For record-keeping purposes and to satisfy the IRS, the terms of a loan to a shareholder should be put in writing and negotiated as if it were an arm's length transaction. The terms should include a repayment schedule and an interest rate. You can choose not to follow these formalities and lend shareholders money from the business interest-free and for an indeterminate length of time, but if the corporation is audited, you run the risk of the IRS re-classifying the loan as compensation that was distributed without the required employment taxes being withheld.
Set an amount for a dividend payment. Dividends are distributions of profit in equal amounts per share to people holding common stock in the company. The company can make a dividend distribution at any time by issuing checks to shareholders.
Write a check directly to a shareholder to repay capital or expenses. This type of withdrawal is simply a return to the shareholder of money that is owed to him. A return of capital is an amount of money that a shareholder put up to start the company with the intent that the money be repaid to the shareholder once other money was raised. Reimbursements for expenses should happen pursuant to a corporate expense reimbursement policy.
Properly record the withdrawal in the corporate accounting system. Communicate to your bookkeeper or accountant the correct classification for the disbursement. Salary requires accounting adjustments to payroll accounts. A loan requires the creation of accounts in the shareholder's name to track payments of principal and interest. Dividend payments require special account tracking and processing so the amounts can be reported to the IRS. Repayment of capital and expenses should change the balances in equity and corporate expense accounts.
Terry Masters has been writing for law firms, corporations and nonprofit organizations since 1995, specializing in business topics, personal finance, taxation, nonprofit issues, and general legal and marketing content creation for the Internet. Terry holds a Juris Doctor and a Bachelor of Science in business administration with a minor in finance.