Tips for Paying Yourself as a Business Owner

Running a business can quickly get in the way of paying yourself appropriately. Here’s how different business structures handle payments to owners, plus tips for including yourself while managing the budget.

Key takeaways:

  • A salary is a regular payment an employee receives, and an owner’s draw is a withdrawal of business funds that can be more sporadic
  • Each business structure has its own implications for paying taxes and paying yourself, and sometimes it depends on the business’s shareholder agreements
  • Tips for paying yourself:
    1. Include yourself in the budget
    2. Think about what you really need
    3. Assess your worth
    4. Keep tabs on business performance
    5. Factor in benefits

Entrepreneurs know that it’s too easy to forego their pay just to keep a business afloat. But most of us can’t afford to work for free or at a significant discount, at least not for long. It’s essential to know how to pay yourself while still effectively managing a business budget.

You can implement strategies to start paying yourself a living wage as an owner while still focusing on boosting the business’s bottom line. Here’s some essential info about paying yourself smartly and tips for getting started.

Salary versus owner’s draw

First, some clarifications: A true salary is when you get a set paycheck each pay period, as you would if you were a regular employee. The nice thing about a salary is that you don’t have to worry about taking taxes out since they’re withdrawn automatically from each paycheck. And you know you can count on a set amount of money every pay period. However, not all business types allow owners to take a typical salary.

An “owner’s draw” is when an owner withdraws funds from the business to use strictly for personal costs. These can be set up to be taken on an as-needed basis or regularly. The benefit of an owner’s draw is that you have more flexibility in what you get paid and can base these payments on how the business is performing.

“Distributive share” is another term to know. These are any owners’ shares of income, whether a credit or gain. These are treated differently when tax time comes around. Sole proprietors and single-member LLCs can withdraw business money, and it isn’t included on their tax returns. But partners, multiple-owner LLC members, and S corporation shareholders record their distributive shares on their tax return on Schedule K. 

Note that the way income is distributed in partnerships and LLCs will vary based on the business agreements.

Choosing the right business structure

As touched upon, whether your business is a sole proprietorship, C or S corporation, partnership, or LLC will matter when figuring out how to pay yourself. Let’s walk through what each business structure looks like as far as payment:

  • Sole proprietors are not employees and do not technically have the paycheck/salary option. Sole proprietors can draw money from the business to get paid, and no taxes are proactively withheld.
  • Partnerships: Partners cannot receive a salary because they cannot be both partners and employees. Partners receive distributive shares from the business and record them on their tax returns. The partnership agreement will govern how profits are distributed.
  • LLCs: Members of LLCs also do not take a salary as an employee. Single-member LLCs treat draws like a sole proprietor does, and multiple-member LLCs like a partnership.
  • C corporation: Shareholders must take a salary. They may also take dividends if allowed, but sometimes profits are put back into the business instead.
  • S corporation: Shareholders must take a salary. Sometimes shareholders have to pay self-employment taxes, but they could take distributions as part of their compensation to avoid these taxes since distributions come from income that was already taxed.

A few other tax considerations: C corporations are doubly taxed, meaning the corporation pays taxes on net profit, and shareholders pay taxes on the income they receive from dividends.

Pass-through entities, which can be sole proprietorships, S corporations, LLCs, or partnerships, pass profits directly to stakeholders, who then report income on their personal tax returns. Pass-through entities do not pay corporate income tax exactly like C corporations usually do.

Tips for managing your business budget and paying yourself

It may just be a temporary reality that you won’t be able to take much from your business until it gets off the ground. You have many expenses to cover, and managing cash flow the right way can make or break the business. Here are a few tips when you’re trying to figure out how to pay yourself:

1. Include yourself in the budget

It’s easy for business owners to pay themselves only when the business is performing well, and what you get paid can vary a lot using this method. You’ll have much more control over your personal income and thus your personal budget if you factor yourself into the budget from the beginning. 

2. Think about what you really need

Carefully consider what you really need to get paid right now on a personal level. This is where you should start when including a salary in a business budget. At the very least, pay yourself enough to get by. Outline your basic living expenses each month, including food, housing, bills, and others that are absolutely necessary. Make sure you can pay yourself at least this much.

3. Assess your worth

When determining how much you need to get paid, compare what you got paid at your last job, if applicable, and what you would be getting paid if you worked for someone else doing the same tasks.

4. Keep tabs on business performance

Say you pay yourself a consistent amount each month to cover your basic living expenses. Make sure that if your business starts doing great financially, you also begin to think about paying yourself more. Include this salary in forecasts and consider increasing pay each period, if applicable.

5. Factor in benefits

Just because you’re not a “regular” employee doesn’t mean you don’t need the same benefits. Write down everything required, including health and dental insurance, retirement savings, and anything else that is a must. Make sure these costs are factored into pay when you decide on a number. 

Work with tax professionals to create the right plan

Sometimes these details are overwhelming, and you need assistance from the experts. The team at Provident CPA and Business Advisors can assist you with understanding the type of business structure to create, any tax implications, smart growth strategies, and more.

Contact Provident today to learn more about our services.

Why and When an IRS Audit Could Happen to You

While uncommon, certain red flags increase the risks of receiving an IRS audit

It’s unlikely the IRS will audit you anytime soon. For the 2019 fiscal year, the organization only audited 0.45% of American taxpayers, a number equal to about one in every 220 people. One reason for this dip was a reduced budget for the IRS, as its 2018 allowance was about 20% lower than in 2010 when adjusted for inflation. 

However, the Biden Administration is looking to increase the IRS’ operating budget once again in a move that could see the number of people audited increase significantly. In 2010, 1.11% of taxpayers received audits, and a return to those numbers isn’t out of the question once the Internal Revenue Service has greater funds at its disposal. 

Of course, the odds of being audited depend on various financial factors, including income and tax reporting habits. Here’s a look at some things that could increase or decrease the odds of ending up on the receiving end of an IRS audit.

Making a mistake

Perhaps the most common reason people are audited is for making a mistake on their taxes. Even a simple error like a typo on your social security number or a simple math miscalculation could throw off an entire return, triggering an audit in the process. 

The good news is that you can typically fix a mistake quite quickly as long as you have the supporting documentation on hand. However, you’ll still have to deal with the hassle of the audit, so it’s best to avoid errors wherever possible.

High expenses or deductions

If you’re writing certain business expenses off, always keep receipts handy. Excessive travel, meal, and entertainment expenses could trigger an IRS investigation because there’s often a thin line between personal and business expenses. For example, if the IRS sees trends in your business expenses that don’t particularly match up with your company’s practices, they might ask for supporting documentation.

Claiming deductions that seem excessive for your income level could also raise suspicion. For example, if you make about $100,000 per year but claim $30,000 in charitable donations to reduce taxable income, you might be audited. 

Schedule C losses

Businesses are supposed to make money, so the IRS will want more information if you have losses on a Schedule C every year. A company should turn a profit three out of every five years at a minimum. If it fails to do so, the IRS considers the business a hobby, which changes the tax structure. 

You are permitted to have the occasional lousy year in business. But if you lose money consistently, you could have to explain it to the IRS and modify filings.

Missing some income

Generally, all income for regular employees should appear on a W-2. However, there are situations where individuals receive money for additional projects, side hustles, and other opportunities that won’t show up there. Those taxpayers have to fill out a 1099 form that reports this extra income to the IRS. An audit is likely if the government finds out about this income and you don’t claim it. 

Real estate losses

Property owners must be careful about reporting a loss when renting a home or office to a third party. The gist is that real estate is a passive activity, according to the IRS, so the amount of loss you can claim is limited. There is an exception, though, if you can prove that you’re a real estate professional. Qualifying as a professional involves working more than 750 hours per year in the industry. 

Underpayment

Failing to pay enough on your tax bill by the deadline can get you audited. The statement has a due date, but you can seek an extension by filling out Form 9465 with your return and agreeing to pay on an installment plan. Basically, if you can’t afford to pay your taxes, the IRS will demand to know why and may investigate your financial situation more thoroughly.

High income

While all of these situations could cause the IRS to audit you, the single biggest reason for these investigations is a high income. In 2015, for example, 8.16% of all individuals making over $10 million per year were audited. It doesn’t stop there, as an additional 4.39% of those earning between $5 million and $9.99 million were subject to investigations, too. 

Individuals making $1 million to $4.99 million in that year had a 2.39% chance of an audit, as did 1.13% of people with incomes between $500,000 and $999,999. 

Joe Biden’s American Families Plan includes $80 billion in additional funding for the IRS, most of which will be used to audit high earners in the coming years. Officials believe this plan could raise over $700 billion in additional tax revenue from these wealthy individuals over the next decade, so carefully planning their tax situations is an essential part of doing business.

Get tax planning and minimization assistance

You don’t want to overpay on your taxes. At the same time, it’s essential that you claim all your earnings and don’t give the IRS any reason to go after you. The best step is seeking a qualified tax planning and minimization service to legally keep more of your hard-earned money without running into issues with the government. 

Provident CPA & Business Advisors offers holistic business guidance to help our clients build great businesses and achieve financial freedom. We also provide proactive tax minimization services, ensuring you can reduce this expense legally and ethically. Contact Provident CPA & Business Advisors today for more information.

Tax Record Essentials for Gig Workers

Gig workers have unique responsibilities for organizing their tax records and paying quarterly balances on time.

Life as a gig worker can be pretty good. After all, you’re usually your own boss, and you can set a schedule that fits in with your lifestyle.

However, there are some challenges, including filling out invoices, collecting payments from clients, and making sure you have enough money on hand to pay your estimated taxes. You don’t have an employer to deduct taxes for you either, leaving you on your own to report all income when tax season arrives.

Here’s a look at some tips gig workers should follow throughout the year to streamline tax season.

What is gig work, exactly?

Before all else, it’s a good idea to define gig work. Keep in mind that it’s a broad definition that covers many different jobs, but in short, it generally means you’re paid for your goods or services without being considered a full-time employee. 

Jobs that count as gig work include delivery driver, online salesperson, short-term rental landlord, or any contract or freelance worker. Renting out your car or equipment or providing a service like babysitting could also count as gig work. It’s estimated that over half the U.S. workforce could be involved in the gig economy by 2027.

If you aren’t on the payroll but are receiving financial compensation for your goods or services, it’s gig work that you’ll have to pay taxes on once you make at least $400. You’re also responsible for making all contributions to Medicare and Social Security, which a traditional employer splits with employees.

Records you need to keep

Streamlining the tax process involves keeping adequate records throughout the year. Organizing these documents can save you money come tax season because doing so will also include an accurate summary of expenses.

  • Expenses: You can use your business expenses to reduce the amount owed. Save all receipts so you have proof of these expenses if the government audits you after filing. You might need to fill out Publication 463, Publication 535, Publication 587, or Section 199A, depending on the type of business you’re operating. These expenses reduce taxable income and can make your overall bill far lower.
  • Income: It’s also essential to keep a detailed record of all your income, of course—and the government will eventually find out about it. Even income that doesn’t show up on your Form 1099 or W-2 must be reported because you’ll owe tax on it. It’s a good idea to collect and keep your sales receipts and note all these amounts to the IRS to avoid later complications.

The more detailed information you keep updated, the less time it’ll take you to submit accurate tax records when the time comes.

Paying your taxes

It’s a good idea to pay taxes quarterly rather than waiting until the end of the year, and the IRA requires minimum quarterly payments that are based on income or the prior year’s tax bill. Any gig worker making over $1,000 per year who does not pay quarterly estimated taxes on time is subject to a penalty fee unless they pay 90% of their total taxes within that year or “100% of the tax shown on the return for the prior year, whichever is smaller.”

You can submit these quarterly taxes using Form 1030-ES. This document allows you to estimate how much you owe based on your quarterly income and expenses. It doesn’t have to be exact, but remember you’ll have to pay the difference at the end of the year if you don’t make sufficient quarterly payments. And any total under the IRS minimum is subject to a penalty. 

Filing a return

As a self-employed gig worker, you may have to fill out Form 1040 or Form 1040-SR, depending on your age. 

When filling out your documents, make sure you don’t forget Schedule SE, which is Self-Employment Tax, and Schedule C, Profit or Loss from Business. If you fail to include some self-employment income, Form 1040-X allows you to amend a return.

Start early and engage professional tax planning services if necessary

One of the best things you can do when reducing your tax bill is to begin the planning process immediately. Many gig workers don’t start thinking about taxes until the last minute, which leads to them paying far more than they would have with a good strategy. You’re likely entitled to deductions that you don’t even know about, so seeking professional assistance is often a good idea. 

The team at Provident CPA and Business Advisors helps businesses grow profitably through better business and tax strategies. Contact us to learn more.

A Basic Guide to the SEP IRA

A SEP IRA can be a smart retirement plan option if you want higher contribution limits, flexibility, and tax advantages. Here’s how they work.

Key takeaways:

  • SEP IRAs are flexible retirement savings options, especially helpful to business owners with few or no employees
  • SEP IRAs have high contribution limits: $58,000 for 2021
  • Only employers can contribute to employees’ SEP IRAs
  • Business owners can change contribution amounts each year, but percentages must be the same for themselves and all their employees
  • Tax advantages include tax-deferred investments and contribution deductions

Self-employed workers and business owners often must establish a more involved tax planning strategy to maximize credits and deductions and comply with all IRS requirements. It can be challenging to find the right retirement option that will help you contribute enough each year and lower your tax burden. 

The simplified employee pension (SEP IRA) could be the right option. Let’s cover how this plan works, who qualifies, and the key tax advantages.

What is a SEP IRA?

The SEP IRA is an individual retirement account that business owners and self-employed workers can create. Employers decide how much to contribute to each employee’s plan, and they can take advantage of a tax deduction for these contributions. For employees, any contributions their employer makes to their SEP IRA are 100% vested right away, which is a big benefit for them as well.

Many business owners decide to go with the SEP IRA because these accounts have high annual contribution limits. Contributions can’t be higher than the lesser of 25% of a worker’s compensation or $58,000 in 2021. Compare these amounts to traditional IRA limits, which are $6,000 for 2021 or $7,000 for those 50 and older.

Unlike other employer-sponsored retirement plans, the SEP IRA doesn’t require certain startup and operating costs, as administrative expenses are low. 

This is also an attractive option because employers can take a break from making contributions if the business is going through a rough patch. Each year, the employer can decide how much or whether they want to contribute. They can lower and raise contributions amounts year-over-year as needed. This flexibility helps smaller business owners offer a retirement savings option without being locked in each year.

Essential eligibility requirements for SEP IRA participants are as follows:

  • They are at least 21 years old
  • They have worked for the employer for at least three years of the last five years
  • They earned at least $600 in compensation in the previous year

An employer must provide access to the SEP IRA if a worker meets these requirements. But individual employers may opt to use “less restrictive requirements, for example age 18 or three months of service, to determine which employees are eligible.” In all cases, the employee owns and controls their account and can make decisions about retirement investments.

A critical note about SEP IRAs is that if you contribute for yourself as the business owner, you’re required to have proportional contributions for each of your eligible employees. In other words, the contribution rate must be the same for you and all of your workers. So, the SEP IRA is usually best for business owners who have few or no employees.

Other facts about SEP IRAs:

  • There isn’t a catch-up contribution for people age 50 or over, as with traditional IRAs.
  • Minimum distributions are required starting at age 72.
  • Early withdrawals before age 59 ½ are subject to a penalty of 10% and are taxed as income.
  • The SEP IRA may be combined with a Roth or traditional IRA.
  • Employees cannot make contributions—only employers.

SEP IRAs are easy to set up and manage, so they’re great options for small business owners and self-employed workers looking for a more flexible retirement savings alternative. The SEP IRA is available to businesses of any size.

SEP IRAs and taxes

As with traditional IRAs, investments within each employee’s SEP IRA grow tax-deferred until they retire, and withdrawals are then taxed as regular income. Contributions and earnings to SEP IRAs can be rolled over tax-free to other retirement plans and IRAs.

There’s not a Roth option for SEP IRAs, in which contributions are taxed now instead of in retirement. However, as mentioned above, a SEP IRA can be combined with a Roth IRA if desired. 

When tax time rolls around, you can deduct the lesser of your SEP IRA contributions or 25% of compensation, though there is a limit on compensation: $290,000 in 2021. For self-employed workers, the deduction amount is 25% of net income.

In sum, SEP IRAs provide: 

  • A low-administrative-cost retirement savings option
  • Several tax advantages, including tax-deferred investments and contribution deductions 
  • Flexibility that is especially helpful to small business owners who want the ability to decide how much to contribute each year

Where to turn with questions

Choosing the right retirement savings strategy for your business can be a big part of your overall growth plan. You always need to understand tax implications and the pros and cons for both you and your employees. 

When you have questions about the best tax planning and business growth approach, contact the team at Provident CPA and Business Advisors. We help you establish the best tax-advantaged strategies that put your business on the right path for a successful future,

Contact us to learn more about our services.