Yes, I ’ megabyte serious – there are legal aspects to compensating yourself if you own the business that ’ mho paying you, and we ’ ra going to go over those today .
Categorizing Your Business
How you can compensate yourself depends on the type of business you run.
- Sole Proprietorship or Partnership: In most cases, you’re not allowed to be on payroll. You can still pay yourself from the company’s income, but that pay is not tax-deductible. Partnership agreements allow for pay to be given in various ways, but it’s usually best to take distributions and make estimated tax payments.
- In both sole props and partnerships, you’ll pay self-employment tax on the full amount of business profit each year. That’s about 15% of your net profits, so be sure you’re making those estimated tax payments to avoid a big tax bill at year-end.
- It’s best to have payments made on a regular basis, rather than drawing out pay whenever you feel like you need (or want) it. This isn’t necessary, exactly, but it does tend to result in better organization and a more accurate understanding of what it costs you to run your business.
- Corporations: Officers (which business owners are) are required to be paid as W-2 wage earners. You’re almost certainly subject to standard taxes, but on the bright side, the pay you take can be deducted as a business expense.
- S Corporations: S Corporations are similar to standard Corporations, but you can also pay yourself through tax-free distributions. Don’t start celebrating – you still need to take an amount in payroll that the IRS would call “reasonable”, which usually means compensation similar to what similar people in similar positions receive. And while distributions are free from Social Security, Medicare, and unemployment taxes, you’ll still need to pay federal and state income taxes on them when you file your personal tax return at year-end. One last thing: keep in mind that your payroll will be a tax-deductible business expense, but your distributions won’t be.
- Limited Liability Companies: These companies are regulated based on state laws, not federal laws. If you have an LLC, the IRS defaults your tax status to either sole proprietorship (if you’re the only owner) or partnership (if there are multiple owners). Alternatively, you can elect S Corporation status with the IRS for tax purposes. As noted above, this tends to be more favorable tax-wise than the distribution-only method that sole proprietorships and partnerships have to deal with.
Don’t Try To Cheat The System
The IRS is increasingly focused on individuals who receive a distribute of money in the form of distributions – after all, certain taxes aren ’ triiodothyronine being paid on that, and the IRS international relations and security network ’ t affectionate of folks that skirt the tax laws .
How much to pay yourself in wage versus distributions is a controversial topic, even among fiscal professionals. It ’ second o to minimize your wage and take more in distributions, vitamin a long as your wage can be defended as a reasonable sum. There are some on-line tools that can help, or your certified public accountant can help guide you to a judicious decision.
good remember that pigs get fat, hogs get slaughtered. If you pay yourself an aggressively abject wage, while taking giant distributions, it ’ s only a matter of time before the IRS comes knocking. Be reasonable, and stay safe.
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Changing Your Business Setup
If you have an existing sole proprietorship or partnership, it ’ s possible to change your election with the IRS to be taxed as an S Corporation. If your business is netting at least $ 40,000/year in profits, that ’ s normally the point where it makes sense to investigate option entity structures to cut down your tax beak. We know some quality tax experts who can discuss this with you, so shoot us a message if it ’ second something you ’ d like to investigate further .
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