Should My Business Pay My Income Taxes?

It depends.

If your business is a C Corporation, then the answer is easy – Yes. The company pays income taxes directly to the IRS and state. The business will issue a check made payable to the IRS for the amount shown on the business tax return – IRS Form 1120.

For all other companies, the answer is no and yes. Let me explain…

Sole proprietors, partnerships, LLCs and S Corporations do not owe or pay income taxes. These companies are “pass-through entities” which means the taxable income earned by the business is passed-through to the owners.

Even though the business does not pay the income taxes directly to the IRS or state, it should provide the cash the owners need to pay the income taxes the business generated from the profit.

The cash should pass through to the owners too. It would be difficult for you to absorb the increase on your personal tax return if your business does not distribute the cash to help pay your taxes.

I own a “pass-through” company. How do I withdrawal cash to pay my taxes?

Summary: The business issues a check to the owners based on the ownership percentages or operating agreement. The owners will deposit the money into their bank account. The owners write a check to the IRS and State for the actual amount shown of their tax return.

Steps to be completed by the business - usually your bookkeeper:

1. Calculate the distribution amount.
   
   
   
2. Create the Distribution Allocation Schedule.
   
   

Legal Tip: Refer to your Operating Agreement for additional guidance regarding distributions.

3. Confirm the business has enough cash to pay the distribution.
   
   
4. Obtain approval from all owners.
   • Review the information with the owners to confirm everyone is on board.
   • Vote and add to the meeting minutes, if required.

5. Issue checks to the owners.
   • Write a check to each owner for the amount shown on the Distribution Allocation Schedule.
   • In your accounting software, code the payment to the owner’s distribution account in the equity section of your chart of accounts.

6. Confirm the owners receive their distribution check at least two weeks before the tax deadline.

Steps to be completed by the owners:

1. Deposit the check into the bank account you plan to use to pay the IRS and the State.
   
   
2. Write a check from your personal checking account to the tax authority for the amount shown on your personal tax return. If you live in a state with income taxes, you’ll write two checks – one to the IRS and one to your state’s department of revenue.

What is the timeline for making the distribution?

Ideally, the owners should receive their distribution no later than March 31^st. This will give the owner time to deposit the money and give their bank time to remove any restrictions on the deposit. The owner will have confidence they have the funds they need to mail their check to the IRS and meet the April 15^th deadline.

Healthy cash flow tip: Instead of waiting until the end of the year to make the distribution, create a process where the distributions are calculated on a quarterly basis so the owners can make estimated tax payments. This will reduce the risk of tax penalties for the owners and stabilize cash flow.

What if the business files an extension, what is the deadline for the distribution?

Keep in mind, the extension provides additional time to file the return. It does not provide additional time to pay the tax that is due. The owners may incur penalties if they do not pay the tax on time.

It’s best to make the distribution by March 31^st regardless of when the business will file the tax return because the business is more likely to have the cash left over from the tax year it relates to and the owners will have the opportunity to pay the majority of the tax on time.

If the business waits until September to make the distribution, all of the cash generated last year may be gone creating a cash crunch. Not only do you have a cash problem for last year’s taxes, but you also have 9 months of the current year to deal with too.

What if the business does not have enough cash to make the distribution?

Your business should have healthy cash flow to match the taxable income it generates and passes through to you.

If the business is short on cash, you’ll need to research why the business is profitable but it ran out of cash.

I’m serious…stop what you’re doing, get out of your chair and research why you do not have cash. All service businesses regardless of volume should generate the cash needed to pay income taxes. Not only do you need to research how the business will pay the current tax bill, but also search for ways to prevent this problem from happening again next year.

Here are few places to help you search for cash:

1. Start with your accounts receivable collection process. It is likely the business is great at selling and delivering the service but not so great at collecting payment. Call past due customers today!
2. Review the tax return with your accountant to find out which expenses are reported on your Income Statement but are not deducted on your tax return. The business may be using cash to pay expenses that are not deductible and are hurting your cash flow. (link to the tax video about M-1)
3. Consider selling inventory, vehicles, equipment or computers to generate quick cash.
4. Borrow only if you run out of other options. Borrowing money to pay taxes will create a snowball effect. If the business does not have cash now, how will it generate enough cash to pay back the loan plus interest? Also, how will you pay taxes next year? This is a dangerous option that should only be used once.

What if one of the owners does not need the distribution?

This may seem like an odd question, but it is very common for business owners to have different tax situations.

For example, one owner may be the primary bread winner that is married with five kids. The business is their only source of income. Another owner may be single without kids that also owns rental property that generates large depreciation tax deductions.

The bottom line is it does not matter whether the owner “needs” the distribution or not. The distribution represents a return on their investment. If one partner receives a distribution, then all of the partners should receive one.

Besides, it may be required by the entity type (S Corp) or the operating agreement.

Are cash distributions taxable?

Distributions normally are not taxable because you are removing cash from the business that was taxed in a previous year.

When the business pays you a cash distribution, the cash account decreases and your equity account decreases.

In rare circumstances, distributions are taxable if you do not have enough tax basis. If your equity account is negative, you may have to pay tax on the distribution. Please discuss with your tax accountant to learn more.

The Bottom Line

If your business passes taxable income to your personal tax return, it should also “pass” cash to you in the form of distributions.

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For educational purposes only and should not be construed as professional advice. Consult with your professional advisors before making changes to your business.