If your income fluctuates based on profit and the IRS deems that a dividend, then, you are charged at the dividend rate rather than the personal tax rate. That dividend tax rate is higher than your income rate until you hit $373k annual salary in 2011/2012, and yes, you would get hit for underpaying taxes.
Publication 535, mentioned further down under reasonable compensation talks further about how income is qualified.
Basically, if you pay yourself $8k/month, and in July have a really great month and pay yourself $40k, the IRS could determine that the $32k you gave yourself is a distribution of profit, and therefore a dividend. Even paying your taxes as if that was taken as a wage could end up being scrutinized by the IRS. If the IRS determines that your wage fluctuates as much as your profit does, and you're audited, you could have an issue.
Lets say you run a consulting company, pay yourself $5k/month, write an IPhone app, sell $200k, hand yourself $200k right there, it is possible that the IRS could take that view. The difference in taxes on $200k of income versus a dividend is 2% or $4000. If that is greater than 10% of the amount you owe at the end of the year, you could be subject to underpayment penalties of another few hundred. In the fictional $32k, the underpayment of tax would be $3200.
I'm not an accountant, but, if you run into any of these situations, you need to know when to talk with an accountant. Even thinking that you paid the proper tax is something best left to someone that does that for a living. And if you're going to find an accountant, do it in October.. give them your numbers for the current year and what you're projecting for the rest of the year and give them time. You still have room to maneuver a bit more than talking to him on March 14th when the forms are due March 15th. Tax planning is almost as important as tax filing.
Note: yes, I was audited due to the above situation - prior to having an accountant. Ironically, it was a contract with the Navy that did it - I thought, finally, I made this money, I am going to pay myself for all of the hard work I put into this and reward myself for the last two years of subsistance living. After all was said and done, the penalties and accountant fees were grossly disproportionate to the $2100 in underpaid taxes.
> That dividend tax rate is higher than your income rate until you hit $373k annual salary in 2011/2012
It was my understanding, confirmed by your link, that dividends are either taxed as ordinary income or at a maximum of 15% in case of qualified dividends.
You seem like you know what you're talking about so am I missing something?
If I recall, a qualified dividend is taxed as a capital gain - 15% for long term (> 12 months), 35% for short term based on the length of time you held the security/shares in startup/corp/whatever. A non-qualified dividend is taxed at your base tax rate. Bear in mind that a dividend can alter your base tax rate, which affects contributions you may have made throughout the year. So, if you were in the 15% bracket and because of this payment get pushed into the 33% bracket, not only do you need to compensate for the cash received, but, the potential tax liability from your new annual base.
If you are given shares in a company after the initial date, I don't know if that resets the calendar, prorates it, etc.
In my case, as the sole shareholder of a closely held Maryland S-Corp, the IRS deemed the cash payment to be a qualified dividend from a company that was 7 months old, therefore, 35%. Overall, it took roughly 2.5 years and about $7k in accountant fees to reconstruct my bad bookkeeping and deal with the IRS, $1.5k in interest and penalties for an unpaid $2100 tax liability.
Again, if your income ever goes crazy for whatever reason, talk with an accountant.
http://www.irs.gov/businesses/small/article/0,,id=101038,00....
Publication 535, mentioned further down under reasonable compensation talks further about how income is qualified.
Basically, if you pay yourself $8k/month, and in July have a really great month and pay yourself $40k, the IRS could determine that the $32k you gave yourself is a distribution of profit, and therefore a dividend. Even paying your taxes as if that was taken as a wage could end up being scrutinized by the IRS. If the IRS determines that your wage fluctuates as much as your profit does, and you're audited, you could have an issue.
Lets say you run a consulting company, pay yourself $5k/month, write an IPhone app, sell $200k, hand yourself $200k right there, it is possible that the IRS could take that view. The difference in taxes on $200k of income versus a dividend is 2% or $4000. If that is greater than 10% of the amount you owe at the end of the year, you could be subject to underpayment penalties of another few hundred. In the fictional $32k, the underpayment of tax would be $3200.
I'm not an accountant, but, if you run into any of these situations, you need to know when to talk with an accountant. Even thinking that you paid the proper tax is something best left to someone that does that for a living. And if you're going to find an accountant, do it in October.. give them your numbers for the current year and what you're projecting for the rest of the year and give them time. You still have room to maneuver a bit more than talking to him on March 14th when the forms are due March 15th. Tax planning is almost as important as tax filing.
Note: yes, I was audited due to the above situation - prior to having an accountant. Ironically, it was a contract with the Navy that did it - I thought, finally, I made this money, I am going to pay myself for all of the hard work I put into this and reward myself for the last two years of subsistance living. After all was said and done, the penalties and accountant fees were grossly disproportionate to the $2100 in underpaid taxes.