A Strategy for C Corporation Shareholders: Tax Optimization of Distributing Retained Earnings

Unlocking Trapped Cash Through Deferred Compensation Plans

Many C corporations can accumulate a substantial amount of retained earnings. These
earnings may be considered “trapped” cash as these dollars are typically not needed as
capital for the business and may not be distributed primarily due to the fact that…

The company shareholder does not want to be subject to double taxation— where earnings are taxed at the corporate level and then again upon distribution to shareholders.

Implementing an MSO and Deferred Compensation Plan

Established MSO C Corporations
For corporations that have already established an MSO, a deferred compensation plan offers
an opportunity to strategically manage retained earnings. Funds already transferred from the
operating entity to the MSO C corporation can be utilized to make company contributions
to a Defined Contribution Supplemental Executive Retirement Plan (DC SERP). These
contributions can be scheduled for payout at a later date, offering a more tax-efficient
distribution strategy.

Setting up a C corporation operating company may seem advantageous by transitioning income from a 37% individual tax rate to a 21% corporate tax rate, but extracting liquidity from a C corporation remains costly due to the dividend distribution being taxed at 23.8%. Under Internal Revenue Code (IRC) Section 162, the corporation can deduct these benefit payments, which then pass through to shareholders. This strategy effectively offsets income tax liability, eliminating the double taxation issue inherent in C corporations.

Mitigating Accumulated Earnings and Profits (AEP) Tax
For companies with an established MSO C corporation, another key consideration is the risk of accumulated earnings and profits (AEP) tax. Funds held within a C corporation without clear business purpose may be subject to AEP taxation. By reallocating these funds into an executive benefit plan, C corporations can avoid AEP tax exposure while simultaneously enabling tax-efficient distributions to shareholders.

It is important to note that contributions to a DC SERP are typically made over a period of time (e.g. 5-10 years), meaning not all retained earnings can be immediately repositioned. However, the long-term economic benefits outweigh this limitation, as the strategy significantly reduces overall tax liability.

Below is a graphic that compares the economics of a C corporation from a shareholder’s perspective assuming distributions from the C corporation vs. an MSO Deferral Plan.

C Corp vs. MSO C Corp - Cumulative After-Tax Benefit

The economics in the bar graph comparison do not account for potential AEP taxation on assets remaining in the C corporation, which would further enhance the economic value proposition of establishing an MSO Deferral Plan.

Conclusion
MSO Deferral Plans provide a valuable tool for mitigating double taxation and optimizing retained earnings distribution in both operating C corporations and already established MSO C corporations. The process is relatively straightforward—especially for companies that have already set up an MSO—requiring only the implementation of a deferred compensation plan with clearly defined provisions. Additionally, this approach can eliminate exposure to AEP taxation while enhancing financial flexibility for shareholders.

By strategically leveraging an MSO and a deferred compensation plan, C corporation shareholders can significantly improve their tax position, ensuring a more efficient and
cost-effective means of accessing corporate earnings.

For more information, email Mezrah Consulting at connect@mezrahconsulting.com
or call (813) 367-1111. Visit our website at mezrahconsulting.com to learn more.

Who We Are

Mezrah Consulting, is a national consulting firm based in Tampa, Florida, with more than 30 years of expertise in executive benefits and compensation consulting for over 300 companies throughout the U.S. As subject matter experts, we specialize in designing, funding and administrating non-qualified executive benefit plans while uncovering value and mitigating risks. Our proprietary cloud-based fintech platform, mapbenefits®, provides enterprise plan management for plan participants and plan sponsors. Our focus is on sharing ideas that enable companies and key personnel to accumulate and preserve wealth on a tax-favored basis through innovative solutions and protect their business strategies and financial performance.

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