February 9, 2018
Working with lots and lots of small business owners I am exposed to many different cash management and business financial practices people keep. One of those that come up a lot is the topic of “how much should I be paying myself?”.
Well there are a few things that are important to consider, and that if of course the The Internal Revenue Service specifically states that corporate officers are to be on payroll and Section 162 of the tax code says you are you be paid “reasonable compensation”, but what does that mean, right?
For some reason a common magic number I see on a profit and loss report is $30,000.
The problem with this…and it’s a big one (sure, with the IRS) But, everything else that it affects…
- Net Profit
- SEP (Self Employment Pension) contribution limitations
- Shareholder Distributions
- IRS – Reasonable Compensation Audit
REMEMBER — WE GET PAID FOR WHAT WE “DO”, AND WE GET A RETURN ON OUR INVESTMENT FROM WHAT WE “OWN”.
If you only work 10 hours a week in the business, then of course the salary may be low…
Every month when I am looking over client financials I am looking to see that the business is making at least a 10% net profit before taxes on reliable casino online. The reason for this is that is really the new breakeven point of a business. Here’s the thing about this though, it is super easy to skew that figure if your bookkeeping is not setup correctly. I see business owners that will pay themselves a low wage on payroll (hey, I’m in compliance), this then reduces labor costs, thus increases the net profit and poof…high net profit business! Then what they will do is take large sums of cash and do it frequently out of the business operating account as a shareholder distribution. Technically speaking, to pull a distribution your are actually “distributing profits”. I’m available for questions to chat about this.
KNOWING YOUR NET PROFIT PERCENTAGE IS CRITICAL
A few years ago we were working with a cabinet shop with six employees and they were trending at 9% net profit and was having cash flow issues because they would have to wait 60+ days to get paid from their general contractors, thus could not bid on the next job and buy materials afford the labor to start until they got paid from the last job. Throwing caution to the wind, they decided to hire a family member because they “needed a job”, and what they failed to do was forecast that additional payroll wage and this brought them to just 3% net or ONE financial blip away from going out of business
The IRS knows this is one of the top dirty dozen tricks business owners will do to avoid paying payroll taxes. So in the event of a IRS audit they can view frequency of the distributions and see they are pulled weekly or monthly and seek to re-class them as payroll wages while assess payroll back taxes to them.
I SUGGEST DOING THIS.
If you are are literally running your business day in and day out, find out what it would be to replace you with someone with a comparable skillset there are lots of salary guides. This might mean that you are now paying yourself $75,000-$100,000+ on payroll and this is something you can live on and pay your personal bills and mortgage with.
Be sure to have in your chart of accounts broken out under wages you have officer compensation showing as a sub account, along with taxes, and payroll expenses, from your employee ways. This is super helpful to break out true labor calculations when you can “see the numbers”.
By paying yourself a ‘market based wage’ you can accurately measure the success and profitability of your business because what it showing as net profit is the real deal and it not being overstated by a low to no salary for the owner. Here is a link to access current salary guides to choose from.
I would encourage you to retain a business attorney for a couple of hours of work to draft up for you a corporate dividend/distribution policy. This has specific language in it that states perhaps the frequency and/or amounts that the corporations distributes profits to its’ shareholders. This would have legs to it in the event of an IRS audit to support your financial actions. Then moving forward you might be distributing profits on the 15th of the month following the close of each quarter, just a thought.
**401K/SEP (contact your financial investment advisor for your specific situation)
When it comes to funding your retirement (you are funding a retirement, right?), you can be putting away up to $18,500 in 2018 as a tax deferral payroll deduction to your 401k/SEP. It has to be done through payroll though, and if your plan has ‘profit sharing’ you are also able to put up to 25% of your salary of the profits from your company to your pension as well. However, if you are paying yourself a super low salary your are only hurting yourself in what you can be putting away and deducting from taxes.
Chief Experience Officer
“Know Your Numbers, Know Your Business”