By: John S. Morlu II, CPA
When small businesses reach the growth stage, things often start to feel more stable. Profits are usually high, daily operations are running smoothly, and business performance becomes more predictable. This stage is often a good time for owners to focus on how they manage their money and handle taxes.
At this point, many business owners want to figure out how to keep more of their money after taxes. With a clearer idea of where the business is headed, they can work with tax experts to come up with plans to make the most of their profits.
Whether it’s finding smart ways to pay themselves, planning for the future of the business, or offering good benefits to keep employees, owners have a lot of choices to make. Tax experts can help by showing them how to navigate tax laws, save money, and make the best financial decisions.
How Business Owners Can Pay Themselves
Business owners have three main ways to take money out of their business:
1. Salary or Guaranteed Payments
- Owners can pay themselves a salary or wage for the work they do, as long as the amount is “reasonable” based on the job. Partnerships can also pay owners through “guaranteed payments,” even if the business isn’t profitable.
- However, salaries and guaranteed payments are subject to payroll taxes, meaning a part of it goes to Social Security and Medicare.
2. Distributions
- S Corporations: Owners of S corporations can take distributions, which are usually tax-free as long as they don’t exceed the amount they’ve invested in the company. Distributions also aren’t subject to payroll taxes, but owners must pay themselves a reasonable salary first to avoid issues with the IRS.
- Partnerships: Partners can take distributions too, but general partners (those who are involved in running the business) must pay self-employment taxes on their share of the profits. Limited partners don’t have to pay these taxes.
- C Corporations: For C corporations, distributions are treated as dividends. Owners pay taxes on these dividends, and the company can’t deduct them as a business expense.
3. Expense Reimbursements
- Another way for business owners to get money is by being reimbursed for legitimate business expenses. For example, if the owner rents office space to the company, the business can pay rent to the owner. As long as the rent is a fair market rate, the business can deduct it, and the owner gets the rental income without paying self-employment taxes.
What Kind of Business You Have Matters
1. S Corporations
- S corporations can be a good way for business owners to save on taxes. Distributions aren’t subject to payroll taxes, but the IRS requires owners to pay themselves a fair salary first. If the salary is too low, the IRS can fine the owner and make them pay extra taxes.
2. C Corporations
- C corporation owners might want to take more money as salary instead of dividends. That’s because salaries are tax-deductible for the business, but dividends aren’t. However, if the IRS thinks the salary is too high, it can reclassify some of it as dividends, which could lead to extra taxes.
3. Partnerships and Sole Proprietors
- Partnerships have flexible payment options, but general partners must pay self-employment taxes on their share of the business profits. For sole proprietors, business income is automatically subject to self-employment taxes, so their options for taking money out are more limited.
How Tax Experts Can Help
Tax professionals can guide business owners through these decisions to make sure they’re following the rules and saving as much money as possible. They can help determine fair salaries, decide the best way to take distributions, and even plan for the future of the business.
By working with a tax expert, small business owners can make smart decisions that allow their business to grow while keeping more of their hard-earned money.
Next, we’ll take a closer look at what “reasonable compensation” means and why it’s so important for small businesses.
Author: John S. Morlu II, CPA
John Morlu II, CPA, is the CEO and Chief Strategist of JS Morlu, a globally acclaimed public accounting and management consulting powerhouse. With his visionary leadership, JS Morlu has redefined industries, pioneering cutting-edge technologies across B2B, B2C, P2P, and B2G landscapes.
The firm’s groundbreaking innovations include:
• ReckSoft (www.ReckSoft.com): AI-driven reconciliation software revolutionizing financial accuracy and efficiency.
• FinovatePro (www.FinovatePro.com): Advanced cloud accounting solutions empowering businesses to thrive in the digital age.
• Fixaars (www.fixaars.com): A global handyman platform reshaping service delivery and setting new benchmarks in convenience and reliability.
Under his strategic vision, JS Morlu continues to set the gold standard for technological excellence, efficiency, and transformative solutions.
