Do Private Companies Pay Dividends and How Does It Work?

Many people associate dividends with publicly traded companies, but private businesses can also distribute profits to their owners. However, the process varies based on the company’s structure, profitability, and financial priorities.

Unlike public companies, which use dividends to attract investors, private firms have greater flexibility in deciding when and how to distribute earnings. Factors such as retained earnings, tax implications, and shareholder agreements influence these decisions.

Corporate Form and Dividend Eligibility

A private company’s ability to distribute dividends depends on its legal structure. Different business entities have distinct rules and tax treatments that affect how profits are returned to owners.

C Corporations

A privately held C corporation can distribute dividends to shareholders. These payments come from after-tax profits and are subject to double taxation—once at the corporate level and again when received by shareholders. The corporate tax rate in the U.S. is 21% under the Tax Cuts and Jobs Act of 2017. Shareholders then pay taxes on dividends at capital gains rates (0%, 15%, or 20%) or as ordinary income, depending on their total taxable earnings.

Before issuing dividends, a C corporation must comply with state corporate laws, which often require distributions to come from surplus or retained earnings. The board of directors determines the amount and timing of dividends. Unlike other business structures, C corporations have no ownership restrictions, allowing dividends to be paid to individuals, corporations, or institutional investors.

S Corporations

S corporations do not pay corporate income tax at the entity level. Instead, profits and losses pass directly to shareholders, who report them on their personal tax returns. Because of this structure, S corporations do not issue traditional dividends but instead distribute earnings as shareholder distributions. These are not taxed again as long as they do not exceed the shareholder’s basis in the company.

S corporations are limited to 100 shareholders, all of whom must be U.S. individuals, certain trusts, or estates. Distributions must be proportional to ownership percentages. The IRS requires that active shareholders receive reasonable compensation before profit distributions to prevent tax avoidance. Misclassifying payments can trigger scrutiny and potential penalties.

LLCs

A limited liability company (LLC) offers flexibility in how it distributes profits. By default, a multi-member LLC is taxed as a partnership, meaning profits pass directly to owners (called members) without being taxed at the entity level. These distributions are considered owner draws rather than traditional dividends.

LLC members pay taxes on their share of the company’s income, whether or not they receive a distribution. If an LLC elects to be taxed as a C corporation, it can distribute dividends, subject to the same double taxation rules as traditional C corporations. Unlike S corporations, LLCs are not required to distribute profits strictly based on ownership percentages. Instead, distributions can be allocated based on the operating agreement, allowing for customized payout structures.

Availability of Earnings for Dividend Payouts

Private companies must have sufficient earnings to distribute dividends. The primary source of funds for dividends is retained earnings, recorded on the balance sheet under shareholders’ equity. This represents accumulated profits after expenses, taxes, and prior distributions. If retained earnings are negative—an accumulated deficit—the company may be restricted from issuing dividends under state corporate laws or lender agreements.

Cash flow is another key factor. Even with positive retained earnings, a company must have enough liquid assets to cover dividend payments without disrupting operations. The statement of cash flows, particularly the operating cash flow section, shows whether a company generates enough internal funds to sustain distributions. Businesses with seasonal revenue fluctuations or high working capital needs often retain earnings instead of paying dividends to maintain financial stability.

Debt obligations can also limit dividend availability. Loan agreements frequently include covenants restricting payouts if financial ratios, such as the debt-to-equity or interest coverage ratio, fall below specified thresholds. Violating these covenants can lead to penalties or loan defaults, making it essential for companies to assess their financial leverage before approving distributions.

Dividend Distribution Methods

Once a private company decides to distribute earnings, the method of payment determines how shareholders receive their share of the profits. The most common approach is cash dividends, where funds are transferred directly to owners based on their equity stake. Companies often set a fixed schedule for these payments, such as quarterly or annually, but they can also issue one-time special dividends when excess earnings accumulate.

Some companies offer shareholders additional equity instead of cash payouts, similar to dividend reinvestment programs (DRIPs) in public companies. This allows businesses to conserve cash while still rewarding investors. Issuing new shares instead of distributing cash can strengthen the company’s capital base, though it may dilute ownership percentages if not carefully structured.

Property dividends are another option, where shareholders receive tangible or intangible assets instead of cash. These may include real estate, inventory, or intellectual property rights. The fair market value of these assets must be determined to ensure equitable distribution, and shareholders should consider potential tax implications.

In some cases, private businesses may distribute dividends in the form of promissory notes, creating a deferred payment obligation. This allows companies to declare a dividend without an immediate cash outlay, promising payment at a future date with or without interest. While this can help manage short-term liquidity constraints, it also creates a liability that must be honored, potentially affecting future financial flexibility.

Tax Considerations for Shareholders

The tax treatment of dividends affects shareholders’ net returns. Qualified dividends are taxed at lower capital gains rates, while nonqualified dividends are taxed as ordinary income. To qualify for preferential treatment, dividends must be paid by a U.S. corporation or an eligible foreign entity and meet the required holding period—typically 60 days within a 121-day window around the ex-dividend date.

Private company shareholders may also face additional tax liabilities. The 3.8% Net Investment Income Tax (NIIT) applies to individuals with modified adjusted gross income exceeding $200,000 ($250,000 for married couples filing jointly), increasing the overall tax burden. State taxes further complicate matters, as some jurisdictions impose their own rates on dividend income.

Structuring dividend payments strategically can help reduce tax burdens. Shareholders actively involved in the business may consider alternative compensation methods, such as salary or bonus payments, which are deductible for the company and lower its taxable income. Trusts and family partnerships can also be used to distribute income across multiple beneficiaries, potentially reducing the effective tax rate through income splitting.