When your C corporation has a profitable year, do you take more salary or pay yourself a year-end bonus? Since you are pivotal to your company's success, paying yourself more in the good years only makes sense. Increasing or decreasing your compensation from year to year based on company performance can also help manage your company's cash flow -- and the amount of income taxes it has to pay.
A corporation may deduct compensation as a business expense if it is reasonable in amount. Distributing profits as salaries and bonuses can help minimize taxable corporate income, although you and other recipients will be taxed individually on the compensation you receive.
You may decide that paying additional compensation is preferable to paying out profits as dividends. Unlike compensation, dividends are not deductible. Result: Corporate profits are taxed twice -- once at the corporate level and again to the shareholders who receive the dividends.
If the amount of compensation paid to you and other shareholder-employees is deemed to be unreasonable, the IRS could challenge your company's deduction for the expense, reclassifying the "excessive" amounts as nondeductible dividends.
To potentially reduce the chances of problems with the IRS, consider these strategies: