When you are a small business owner, knowing how and what to pay yourself can become a complicated situation. In fact, there is an entire page devoted to the topic on the IRS website. Paying oneself properly will make tax time a bit less stressful and can reduce head-aching causing scenarios! Depending on which type of filing your business is under, there will be differing parameters around which to operate. Below are some essential rules to keep in mind as you set up your compensation plan.
FEDERAL TAX PAYMENT
Filing your taxes on a quarterly basis and making the estimated payment is always a smart strategy and one that you should adopt immediately if it is not your current practice. Federal tax treatments vary from LLCs, to Corporations and S Corps. Your tax professional will direct you to the most appropriate treatment for your situation, but there are few guidelines that are applicable to many situations. LLCs with one member are considered a sole proprietorship, and those with multiple members are classified as a partnership. LLCs cannot pay owners a salary, but draws can be made as an owner’s withdrawal. All profits made under an LLC fall under self-employment tax.
ARE DRAWS A GOOD OPTION FOR YOU? (IF YOU HAVE AN S CORP)
Quickbooks advises that owners of S Corps compare how being paid by salary will differ from the overall tax treatment of taking draws and create the payment structure that provides that most advantageous tax treatment. Owners of corporations must pay themselves a salary, with all deductions withheld, through the payroll system. Payroll services can perform all of the necessary functions, you will need to first determine your salary levels.
Draws, for those who have filed as an S Corp, can be paid by check and without any deductions. However, do not forget to track these payments throughout the year as they will also need to be reported as income. Be aware that your salary and any draws must be in line with what the IRS describes as a reasonable compensation amount. Determine what the general compensation level is for comparable positions in your area and industry.
HOW A TAX REFUND CALCULATOR CAN HELP YOUR TAX PLANNING
As a small business owner, you definitely do not want a tax refund. Most businesses are run on razor thin margins, and allowing the government to hold your money on an interest-free basis is always a bad idea. Use a tax refund calculator when estimating your quarterly payment in order to minimize the likelihood of overpaying. Additionally, be mindful of the fact that you will have two tax payments in April: one for the prior year’s tax as well as your regular quarterly estimated payment.
UTILIZING CREDIT FOR BUSINESS EXPENSES
If you use credit for your business expenses, be certain to have a fully dedicated card that is issued in the business’s name. This cannot be overstated! Using a personal card for business expense opens you up to additional scrutiny from the IRS and can also complicate a business partnership. It is always best practice to not mingle personal funds with those of your business. If in doubt, take a draw from the company, and in the inverse situation, make an owner’s contribution.
The first step is to determine the appropriate salary level or your desired amount of compensation and then work with your tax advisor to determine the best way to pay yourself. There are many pitfalls associated with paying oneself through a small business and it is best to seek the guidance of a tax professional in order to avoid any future issues with the IRS.
As a small business owner, it is important to pay yourself both a living wage as well as a reasonable one. Do not take an improvisational approach to this topic as it is one that often appears on the IRS’s list of hot button issues. For this reason, and many more, it is key to have a trusted tax advisor on your team.