Q: I am the 100% owner of a CA C corporation

A: You've missed a few things.

There are a few potential outcomes from a tax perspective.

1. These are gifts from you to her and the IRS and CAFB will pretend you took a dividend and then gifted her those amounts.

2. She has constructive dividends from the corporation.

3. She has independent contractor income from the corporation.

From what you've stated:

1. She may have tax liability based on the interpretation of the transaction by the taxing authority.

2. Whether your corp deducts the payments will go towards treatment of her receipt of the amounts but may not be dispositive.

3. Depends on 2 whether you pay income tax, essentially if you don't deduct it then yes you pay income tax on it.

4. Also depends. It seems you want these payments to be considered gifts. In that case you're mistaken, the 706 is required when you exceed the annual exclusion currently $15,000 per person per year. After that you are required to file Form 709 (Gift tax return) reporting the excess over the annual exclusion. No tax would be due if you have not exceeded you lifetime exclusion amount of $11.4MM. However, that lifetime exclusion changes. It currently increases every year for inflation but is set to revert to $5MM in 2026. When you pass your estate will be required to file a form 706, again you may not pay any tax but the form is still required. Not filing these can result in audits and much time and effort spent providing documentation to an auditor to prove no tax is due.

If you have a specific plan in mind for these transactions, which you seem to have, you should take the funds personally, make the gift properly, and file the 706 annually. This would ensure the transfers are treated as gifts as you intended and avoid potential headaches in an audit.

Essentially you're where you want to be but you skipped a few steps and you're hoping the IRS and CAFB gets the idea and is ok with it which is not guaranteed and will probably be expensive to fix.