Smart Ways to Pay Yourself as a Small Business Owner
January 22, 2020
Courtesy of The Ahola Corporation
While the government generally dictates how you can pay yourself with a salary or the equivalent of a salary, it also provides flexibility for you to make withdrawals. In addition to direct compensation, there are ways you can compensate yourself indirectly for now or for the future. Your organization structure influences how you can pay yourself as the owner.
If you’re structured as an S Corporation, the law requires that you put yourself on the payroll. You must receive regular checks and pay federal, state, Social Security and Medicare taxes on your earnings.
If you’re a sole proprietor or a partner, for example in a limited liability company, you can’t put yourself on the payroll because you’re an owner, not an employee. However, you can pay yourself the equivalent of a salary, called a guaranteed payment.
It’s important to pay yourself at least enough to survive, but not so much that it impedes the company’s success. Whether you own an S Corporation or an LLC, you are permitted to take additional withdrawals from the company’s profits.
Many small business owners wait until the end of the year to determine what those profits are and then allocate themselves a portion of the profits as a bonus, which you can take as a withdrawal. Withdrawals aren’t subject to payroll taxes, but if you’re a sole proprietor or partner, you’ll pay self-employment tax on everything you withdraw from the business.
In addition to direct compensation such as a salary or bonus, there are ways you can direct more of your company’s profits to you and your family, either for now or later.
For example, hire your kids for the summer. You’ll teach them money management skills, expose them to entrepreneurship and teach them some lessons about worth ethic. You’ll also be able to keep more of your business profits for you and your family.
If your kids are under 18, they don’t pay any Social Security, Medicare or workers’ compensation taxes.
If they earn less than the standard deduction, they won’t pay any income tax on what they take home, either, and you can still claim them as exemptions. You’ll need to provide them with real jobs and a fair wage for the work they perform.
When you hire your spouse, your spouse becomes an employee. The salary you pay to your spouse keeps money in the family, and your spouse might be eligible for company contributions to a retirement plan, health care and other benefits that you can’t receive as a sole proprietor.
Have the company make contributions to your retirement account. You might be able to create a non-qualified retirement plan for yourself that provides tax-deferred retirement income funded by the company.
If you have a substantial amount of profit to distribute, a non-qualified defined benefit retirement plan might allow the company to contribute as much as $250,000 a year toward your retirement. These expenses, however, probably won’t be tax deductible for the company.
Pay yourself in perks. There are some perks the company can provide that make sense. Paid parking, for example, is both tax-deductible for the company and exempt from Social Security and Medicare taxes.
Rather than making a charitable gift yourself, you might have the company make it. Business-related travel is also reimbursable by the company.
Tax laws and tax rules are constantly being updated and interpreted. This article contains general information, so please discuss your individual situation with a trusted tax adviser before making tax decisions.