Such an approach may reduce the taxable income of the C corporation to an acceptable level and result in the earnings being taxed only once at the shareholder-employee level. Moreover, while in some businesses high amounts of compensation as a percentage of corporate income may be reasonable (e.g., where personal services are the principal contributor to income, such as in a dental practice), in other businesses where capital is a principal contributor to income (e.g., rental real estate or manufacturing and sales with large capital investment), compensation that is a high percentage of pre-tax corporate income may be more difficult to justify.
Small business corporations are either C or S corporations — these designations refer to the subchapters of the tax code that governs them.
C corporations are governed by 26 USC Chapter 1, Subchapter C - Corporate Distributions and Adjustments.
A corporation will not recognize any gain or loss on a distribution of cash to its shareholders. But if the corporation distributes appreciated property, the corporation must recognize gain as if the property were sold to the shareholder at fair market value. Important Note: These two rules operate as a loss disallowance system.
If the corporation distributes appreciated property, the corporation is taxed on the gain under Code § 311(b).
Many C corporation benefits, such as health insurance, are not subject to either ordinary income taxes or employment taxes, while fringe benefits offered by other business entities are always subject to employment taxes.