Should I pay myself salary or dividends in the US?
It depends heavily on your entity type. For a C corporation, dividends are taxed twice — once as corporate profit and again on your personal return — while salary is deductible to the corporation and taxed once, so salary is often more efficient. For an S corporation, owners must take reasonable salary (subject to payroll tax) and can take remaining profit as distributions.
What is the reasonable compensation rule?
The IRS requires owner-employees of an S corporation to pay themselves reasonable salary for the work they perform before taking tax-advantaged distributions. Paying an artificially low salary to dodge payroll taxes can trigger reclassification, back taxes and penalties. 'Reasonable' means comparable to what similar businesses pay for similar work.
How are qualified dividends taxed?
Qualified dividends are taxed at long-term capital gains rates — 0%, 15% or 20% depending on income — which is lower than ordinary income rates. However, for a C corporation the dividend is paid from profit that was already taxed at the corporate level, so the combined effective rate can still be high because of double taxation.
What is double taxation of dividends?
Double taxation means a C corporation's profits are taxed first at the corporate income tax rate, and then the after-tax profit distributed as dividends is taxed again on the shareholder's personal return. This is a key reason many small businesses elect S-corporation or pass-through status, where profit is taxed only once at the owner level.