Is there a case where it does makes sense to put write off salary as loans to the founders? As the OP indicated, any sophisticated investor would insist all the money goes "forward." But even if the company bootstrapped it to profitability, there would be no difference in tax due using this accounting practice, is there?
Is there any advantage at all to doing it this way?
Their salary was $100k, of which (say) $80k was returned as a loan from the founder to the company.
This lets the company book $100k of costs on a net cash outflow of $20k. Costs are applied before calculating profit and therefore before calculating taxation due. At a corporate tax rate of 20% that would be worth $16k more than the tax deduction due from paying salaries of $20k.
Tax losses can be deferred until you make a profit in most tax regimes so that $16k will be held over until you need it to avoid paying taxes on the first $80k of corporate profits no matter when they happen.
It may also be possible to essentially sell tax savings to other companies under some circumstances (usually when winding up a company).
Overall this scheme would probably cost money as employment taxes would be due. But that can vary depending on other tax breaks, especially in progressive taxation systems. You may also be able to do something interesting with loan interest repayments which are often subject to tax breaks. Tax codes for Western countries are huge and full of interesting possibilities!
What I don't get is, if you pay yourself $100K, aren't you personally taxed on your 100K income?
Or, will you claim you only had a 100K - 80K = 20K income on your personal taxes? I would think the government would try to match up the $100K company expense with a $100K personal income (and if they don't match, audit you).
I'm actually really curious if you can pull this kind of thing off.
My position is that the salaries were really just our egos. We didn't have the money to pay ourselves over $100k. The $20k "example" is actually pretty close.
Ideally, take what you can to pay your mortgage. Put that on the books. Spend time getting profitable instead of balancing the books. If you become profitable, or get a nice round, it'll all work out :)
You are correct that taxes would be owed on $100k of personal income.
This may be less than the expected saving from avoiding corporate income tax due to:
- Tax free personal allowance (soon to be $15k for the UK).
- Tiered rates of personal income tax (for example a 10% lower band up to a threshold).
- Deductions or grants for persons working in enterprise zones/for small companies/for start ups/for technology companies/in strategic industries which are only reclaimable once personal income crosses a threshold. (Common in places like Northern Ireland.)
- Employees and employers not in the same tax region, allowing for {evasion|avoidance} schemes.
The whole thing gets really complicated very quickly, and if your two man startup is engaged in tax manipulation to that level you are probably missing the forest for the trees. If a $20k tax saving distracts you from a shot at a $1bn market you are doing it wrong.
(Unless you know a huge check is arriving next quarter, or some other special circumstance applies.)
Debt is senior to equity, so in the event the company went basically sideways and ended up being closed down, holding legitimate debt puts you in front of, for example, angel investors holding equity.
In the success or spectacular failure case, I can't see that it gives any advantage. (In fact, in the losing case, you would presumably have to pay taxes on the salary you never received and then might get different/worse tax treatment on the bad debt. Even in the winning case, you'd pay payroll taxes and FICA on the "phantom" salary.)
There isn't. It actually may cost you depending on the personal taxation rate, usually that one is a lot higher than corporate taxes on the same amount of money.
On another note, if you spend a lot of time during your start-up years (say the first three) on stuff like this you are likely doing something wrong. That sort of number wizardry only pays off when the amount of turnover starts to be significant enough to look at what you're going to do with the excess money. Hardly any start-up finds itself in such a luxurious position.
Great post that brought back some memories. In 2001 I was hired by a startup that was in a very similar situation. When they ran out of cash 5 months later I could tell it was much harder on the founder than it was on me, since not only did he need to let me go but his startup dream was ending. He let me continue to use the machines until the doors finally closed, and I ended up landing a good contract position all negotiated from that very equipment.
Is there any advantage at all to doing it this way?