Start-Up Costs

Especially in the early days of a business, owners typically find that they must retain some profits in the corporation to buy inventory and equipment, meet payroll costs, develop new products, and cover other expenses of a growing business. Fortunately, up to $75,000 of these profits will be taxed at the lower corporate tax rates.

Increased Profitability

As a business matures and begins earning more than it needs to fund growth, the owners will no doubt want to pay out more corporate profits to themselves in the form of salaries and bonuses. Regardless of the possible continued savings from income splitting, owners are likely to increase their salaries or declare bonuses if the corporation's cash reserves are adequate to meet foreseeable needs. Plus, the possibility of savings from income splitting decreases as more profits are kept in the corporation -- rarely will a corporation save money by retaining more than $100,000 of profits in the corporation each year.

IRS Limits on "Accumulated Earnings"

The IRS may limit the amount of money your corporation can retain. Usually, you can keep a total of $250,000 of "accumulated earnings" in the business at any one time, no questions asked (for professional corporations, this amount is limited to $150,000).

You can retain more earnings if you have a valid business reason, but if the IRS decides you are simply trying to lower your taxes by keeping profits in the corporation, you can be hit with a penalty tax. This penalty can easily wipe out any benefit you received by keeping excess money in the corporation.